‘Gradual Recovery’ Foreseen for World Economy

Global growth will accelerate gradually in 2014 and 2015, but risks are weighted to the downside according to Fitch Ratings says in its latest Global Economic Outlook (GEO).

The credit ratings agency (CRA) said that the pick-up this year is driven by a strengthening recovery in major advanced economies (MAE), while growth slows in emerging markets (EMs).

The latest forecasts for world gross domestic product (GDP) growth (weighted at market exchange rates) are 2.7% in 2014 and 3.1% in 2015 and 2016, up from 2.4% in 2013. The 2014 and 2015 forecasts are 0.2 percentage points (pp) and 0.1pp lower, respectively, than in the previous, March GEO.

Nevertheless, deflation in the eurozone is a meaningful risk, says Fitch, and the US Federal Reserve’s path towards normalising monetary policy could trigger heightened financial market volatility, global trade growth could slow further and higher oil prices could hurt growth in most regions.

Fitch is projecting a bounce-back in the US economy after the revised, unexpected contraction in Q114. The CRA forecast real GDP growth of 2% in 2014 (revised down from 2.8% in the March GEO), 3.1% in 2015 (unchanged) and 3% in 2016.

Growth in the US is broadly based. Private consumption growth is underpinned by improving household incomes, net wealth and employment; while investment is supported by healthy corporate balance sheets and a recovering housing market. Monetary policy remains highly accommodative and the drag from fiscal consolidation is significantly smaller than it was in 2013.

Eurozone Recovery Fragile

Fitch notes that the recovery remains fragile in the eurozone and recent data is mixed among member states. It projects eurozone GDP growth of 1.1% in 2014, followed by 1.5% in 2015 and 1.6% in 2016. Germany and Spain are expected to outpace France and Italy in the next quarters, in contrast to the previous core-periphery dichotomy. Recovery will become more balanced as domestic demand benefits from an easing in the pace of fiscal consolidation, improved confidence and normalisation of financial conditions. However, high unemployment will persist and remain above 11% until 2016.

The CRA’s base case remains that there will be a period of very low inflation (0.9% in 2014 and 1.3% in 2015 and 1.5% in 2016), significantly below the European Central Bank’s (ECB) target, but a protracted, self-reinforcing deflation will be avoided, owing to rising output, anchored inflation expectations and the ECB’s capacity for policy response. Nonetheless, deflation or very low inflation is a meaningful risk that could raise real interest rates and debt burdens, and add to the costs of periphery rebalancing.

Growth in the UK has been buoyant and above medium-term potential, consistent with a closing of the output gap. The composition of growth has become more balanced over recent quarters as business investment has picked up and the initial surge in consumption has moderated. Fitch forecasts UK growth to moderate to 2.5% in 2015 and 2.3% in 2016, from 3% in 2014.

For Japan, the CRA expects growth of 1.6% in 2014, and 1.3% in 2015 and 2016, though the 3pp consumption tax rise that took effect in April adds to uncertainties. Notwithstanding the publication of the latest government documents the potential for ‘third arrow’ structural reforms to deliver sustainably higher nominal and real GDP growth over the long term remains highly uncertain.

Emerging Markets

Fitch expects EM growth to slow to 4.3% in 2014 from 4.7% in 2013, before firming to 4.8% in 2015 and 4.9% in 2016. Constraints from infrastructure bottlenecks, business environments and unbalanced growth models have reduced medium-term growth potential in many countries. Other headwinds include volatile funding conditions, weaker non-oil commodity prices, a slowdown in global trade growth and political shocks.

Fitch expects China’s GDP growth to moderate to 7.3% in 2014, 7% in 2015 and 6.7% in 2016 amid gradual rebalancing and efforts to contain leverage. In contrast, we forecast growth in India to increase to 5.5% in 2014 and 6.5% in 2015 and 2016, from 4.7% in 2013, owing to a step-up in structural reforms by the new government. Growth in Brazil and Russia will slow further in 2014 to 1.5% and 0.5%, respectively and only improve modestly in 2015 and 2016.

Fitch expects the Fed and Bank of England (BoE) to start to gradually tighten policy over the next 12 months as the US and UK economies strengthen, in line with forward guidance. Normalising monetary conditions after over five years of virtually zero interest rates and unwinding quantitative easing (QE)-inflated balance sheets is historically unprecedented and may well trigger some increase in financial market volatility from unusually low levels. This will also create a divergent path with the ECB and Bank of Japan (BoJ), which are still loosening monetary policy and expected to keep interest rates unchanged to at least 2016.

Fitch also explores the risk to the global economy from the Ukrainian crisis. The simulation results of a combined financial, trade and energy price shock show that a recession of 3.5% in Russia in 2014 would lead to only 0.2pp-0.3pp lower GDP growth in the eurozone in 2014 and 2015, and less in other MAEs. However, an extreme shock involving a cessation of Russia energy exports would be more damaging.

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