Three key developments already shaping 2015

Our core economic scenario for this year featured seven potentially key developments. Three of these have already struck in the very first month of the year: firm anchoring of US growth; ECB quantitative easing; resurgence of systemic risk in the eurozone.

Economies throughout the industrialised world have been benefiting from the slump in the price of oil. All the liquidity being injected via the European Central Bank’s quantitative easing programme is providing a welcome pillar of support for the eurozone. On the downside though, the outcome of Greece’s general election has reignited the risks of a systemic crisis taking hold.

Oil price a factor offering support

When we compiled our core macroeconomic scenario for 2015, we pinpointed seven potentially crucial developments. Of those seven, three materialised in the opening month of the New Year. The first of these relates to the US economy. Even though the US dollar has been climbing, economic growth in the US has locked on to cruise control at a rate of over 3%. As a result of the 50% plunge in the price of a barrel of oil since June 2014, the US economy is being bolstered by more robust consumer spending as households’ spending power has been given a boost. This economic momentum has gained the upper hand over a negative factor: the shrinking contribution to GDP coming from capital investment. This can be blamed on the quite understandable slashing of spending plans by oil production and services companies. As a corollary, we estimate US GDP is likely to expand by 3.4% this year, a fraction or more above our previous 3% projection.

Second, the European Central Bank (ECB) has announced its quantitative easing (QE) programme. The scale of this is much in line with what we had expected. On a less positive note, it is likely to be less effectual than the QE packages put in place by the US Federal Reserve. There are a couple of reasons why. To start with, the ECB’s QE is being implemented in a deflationary environment. Moreover, it lacks any fiscal or budgetary pillar.

Third, systemic risk in the eurozone is once again looming threateningly large in the aftermath of the victory of the vehemently anti-austerity parties in the recent Greek elections. In the weeks ahead, talks between the Greek government and the Troika will inevitably cause the pendulum to swing between fears and confidence about the future sustainability of the eurozone.

US: we have upgraded our forecasts for growth in 2015

The US registered annualised q-o-q GDP growth of 2.6% in Q4 2014, somewhat slower than expected according to consensus projections (+3.0%). It should be borne in mind, however, that a big spike in defence spending had fuelled the impressive rate of GDP growth (+5.0%) recorded in Q3, so a whiplash effect on this component of demand was the main reason for the slowdown reported for the final quarter. If we look beyond short-term fluctuations in GDP numbers, the broader picture shows the US economy to be enjoying sustained and robust growth. Despite this, the economic outlook is not particularly straightforward to forecast. On the plus side, vigorous momentum in employment and lending growth, the recent fall in long-bond yields and, above all, the feed-through impact on consumer spending from plunging oil prices should be good for growth. On the minus side, the adverse impact of lower oil prices on investment and output in the oil industry, compounded by the effect of the firmer dollar on foreign trade, will act as a brake. All things considered though, the pluses should comfortably outweigh the minuses this year, especially in the first half, but less so as the year progresses. All in all, we are forecasting GDP growth should settle at close to 4% for Q1, but the tempo is likely to ease back to just under 2.5% by Q4. When it comes to GDP growth averaged over the whole year, we remain upbeat and have upgraded our estimate from +3.0% to +3.4%.

Against a backdrop of growth running at that pace and unemployment continuing to fall steeply, the most plausible scenario will be for the Fed to make a start on hiking the Fed funds rate in June. Admittedly, in the aftermath of the dollar’s recent advances and the softening of inflationary expectations, the chances of the Fed delaying the onset of rate hikes have undoubtedly increased.

Eurozone: QE programme as a response to deflationary risks

According to Eurostat’s latest estimates, consumer prices in the eurozone fell by 0.6% y-o-y in January, after a rate of -0.2% in December, chiefly on the back of tumbling energy prices. The weakness was not just down to the slide in commodity prices though; shrinking demand has also played its part. Core inflation sank to its lowest rate since the eurozone was founded, registering 0.5% y-o-y in January. Fast-subsiding inflation in the eurozone finally persuaded the ECB to embark on a far-reaching programme of asset purchases encompassing sovereign debt for a total of €60bn a month up to at least September 2016. The main benefits of this programme should be to stop the rot in inflationary expectations. The QE package should also cause the euro to weaken and stimulate expansion in both the money supply and lending. It probably will not be enough, however, to stabilise the actual rate of inflation. An outcome of negative inflation being recorded for 2015 cannot be ruled out as a possibility.

In parallel, findings from economic surveys and hard statistics have been perking up a little, especially those reported for Spain and Germany. This is exemplified by the Ifo survey, a barometer of German business confidence. Its reading climbed to its highest for six months in January at 106.7 points, up from 105.5 in December. That bodes well for the German economy after an extended bout of weakness lasting several months in 2014.

Looking ahead a few months, drivers that could energise the eurozone economy should multiply: weaker euro, lower oil prices, end to austerity and quantitative easing. Given that outlook, we have upgraded our forecasts for eurozone growth. We are now projecting GDP growth of 1.1% over the whole of 2015, up from 0.8% previously. The recovery will be patchy though. We would expect to see robust growth in Germany and Spain whereas the outlooks for Italy and France remain very variable and unsettled.

Switzerland: recession looks on the cards for this year

The Swiss National Bank’s move in mid-January to remove its exchange rate cap on the Swiss franc against the euro is still creating waves. After soaring immediately, the Swiss franc gradually eased back, probably courtesy of some significant intervention in the markets by the SNB. Even at today’s lower level (CHF1.05 to one euro), the franc is still noticeably overvalued. Its average real trade-weighted value has jumped by about 13% since December 2014. In terms of its impact on tightening monetary conditions, appreciation on that sort of scale is more or less equivalent to a rise of 350-400 basis points in short-term interest rates. Even after making allowance for the recent further pruning of short-term rates by half a point (from -0.25% to -0.75%), the monetary screws have undeniably been severely tightened. The franc could, of course, lose a little more ground. Indeed, under our baseline scenario, we envisage the Swiss franc moving back towards a rate of CHF1.10 to one euro before the year is out although the depreciation process is likely to be very gradual and uneven. The negative impact on economic growth and inflation is likely to be quite potent. Switzerland’s economy can, therefore, be expected to experience at least two quarters of contraction this year, with prices dropping quite steeply. We are forecasting GDP growth of only around 0.5% for this year and inflation as deep into the negative zone as -1.5%.

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