Meaningful global recovery hopes have all but vanished

ECONOMIC circumstances worsened during 2011. Now, going into 2012, growth expectations are downbeat almost everywhere. The eurozone crisis is still overshadowing other major problems. A disorderly disintegration of the euro, with disastrous consequences for banking systems worldwide, will remain for some time the major global threat. But other risks, though less acute, cannot be shrugged off. In particular, the US’s unresolved fiscal problems, and concerns over a “hard landing” in both India and China, can unsettle the markets this year. In addition, the tensions in the Gulf between the US and Iran may trigger damaging surges in oil prices.

Most analysts are now forecasting that the eurozone economy as a whole will record an outright GDP fall in 2012. Germany’s impressive growth in 2010 and in much of 2011 will be followed by virtual stagnation in 2012. Italy, Spain and other weak economies will probably record big GDP falls this year. This is a very disappointing situation so soon after the last recession, since most eurozone economies still have plenty of spare capacity. Although monetary policy remains accommodating, Germany’s adamant insistence on tough fiscal austerity increases the danger that the eurozone downturn would worsen further before it stabilises. The European Central Bank (ECB) is doing its best to lessen the downward spiral, by cutting interest rates and by providing cheap bank liquidity. Eurozone annual consumer price inflation has started to slow, to 2.8% in December 2011 from 3% in November, and this will make it easier for the ECB to relax policy further. But the ECB cannot fully offset the impact of other misguided policies.

After cutting its key policy rate to 1.25% in November 2011, the ECB reduced its rate to 1% in December, and we expect a further cut to 0.75% early in 2012. Though rates are unlikely to be raised at least until Q1 2013, the ECB is still unduly constrained in its ability to support growth. Mainly due to German opposition, the ECB cannot act as lender of last resort to vulnerable periphery governments, and is limited in its ability to increase the money supply through quantitative easing (QE).

With eurozone unemployment rising to new highs, and with divergences between the core and the periphery widening, new crises will inevitably flare up. Though the euro is unlikely to disintegrate this year, serious threats will persist. A radical restructuring of the eurozone is most likely to occur in the second half of 2013 or in 2014, after the 2013 German general elections.

Financial mirror

In contrast to the eurozone’s worsening prospects, the US economy is gradually improving on many key measures. The Conference Board’s US consumer confidence index rose to its highest level since April. The US housing market, though still under pressure, is now stabilising, and there was a welcome improvement recently in both housing starts and building permits.

Most significantly, the US labour market is steadily strengthening, although it remains weak by historical standards. The US economy created 200,000 new jobs in December 2011, more than analysts predicted, and the jobless rate fell to 8.5%, the lowest rate since February 2009. The US manufacturing PMI (Purchasing Managers’ Index) rose in December to its highest level since April, while the comparable eurozone index signalled declines in activity for a fifth consecutive month.

The financial markets mirrored these economic divergences. Whereas US share prices managed a marginal net increase during 2011, the main German and French stock market indices fell by some 15-18%. In the currency markets the euro fell to a 16-year low against the US dollar. One should stress that US overall performance is still mediocre rather than sparkling. In spite of recent progress, most jobs US lost in the recession have not yet been recovered. But trends are moving in the right direction, and pro-growth policies are more forceful in the US than in the eurozone. The Federal Reserve will keep its exceptionally low policy rate at 0-0.25% at least until Q2 2013 and, with inflation falling, may inject a further dose of QE.

Hard landing

In the UK, the recovery has stalled. GDP will stagnate overall until the middle of 2012, with one quarter probably recording negative growth. But a major recession is unlikely. The UK has gained considerable credibility in the financial markets because the government forcefully implemented its deficit-cutting programme. Britain’s AAA credit rating is safe at present. Yields on UK bonds are now only marginally higher than German bonds, and lower than those of other eurozone countries. The fiscal plan provides the government with flexibility to increase infrastructure spending, and this will support activity. With inflation set to fall sharply, I expect an early additional increase in QE, to £325bn. Official UK interest rates are likely to stay at 0.5% at least until Q1 2013.

Both the Chinese and Indian economies are also now growing more slowly, and their policy priorities have changed. Though inflation is still a concern, the main focus now is on preventing a hard landing. India will relax policy more slowly, because its currency has weakened in recent months. But in China the central bank will soon announce a further cut in the required ratio of reserves that banks are required to hold. This would free up funds that could be used to increase lending and support economic growth. ?