Australian inflation is easing, interest cuts are on the cards for the Reserve Bank and despite much of the gloomy comments about the local economy; things are not all that bad. Likewise with other major economies and the world, conditions seem to be better than the gloomy forecasts from the IMF and World Bank suggest.
Greece, perhaps Portugal and the eurozone as a whole remains a flashpoint and further problems and pressures on global growth, China and the likes of Australia can’t be ruled out.
But Dr Shane Oliver, chief economist and strategist of AMP Capital Investors is cautious, not pessimistic about the prospects for the world economy this year, as he was last year in his list of lists for things to keep an eye in 2012.
The past few weeks have been interesting.
Sovereign rating downgrades in Europe have intensified.
The World Bank and now the International Monetary Fund (IMF) have slashed their growth forecasts for this year and warned of the risk of a global downturn worse than that associated with the Global Financial Crisis (GFC).
Yet share markets and other risk trades have almost said “ho hum”.
So what’s going on?
Our take is the markets are telling us that a lot of the bad news has already been factored in.
The ratings downgrades were flagged back in early December and the World Bank/IMF growth forecasts downgrades have only just caught up to private sector economists.
This is not to say we are out of the woods, or that volatility will disappear.
But it does seem the risk of a global financial meltdown has receded somewhat and that the global economic recovery appears to be continuing.
Europe – reduced risk of a financial blow up
Europe is on track for a mild recession but the risk of a financial blow up resulting in a deep recession seems to have receded a bit.
The provision of cheap US dollar funding by the Fed and very cheap euro funding for three years by the ECB under its long term refinancing operations appears to have substantially reduced the risk of liquidity crisis causing banking collapses.
It has also reduced pressure on European banks to sell bonds in troubled countries.
We would have preferred the ECB to have directly stepped up its buying of bonds in troubled countries, but its back door approach has nevertheless seen a sharp expansion in the ECB’s balance sheet.
In other words, it appears to have embarked on quantitative easing, albeit it wouldn’t admit it.
Reflecting this, bond yields in Spain, Italy and France and spreads to Germany – which were surging towards end last year – have settled down.
Similarly European bank stock prices appear to have stabilised.
This is not to say Europe is no longer a source of risk.
It still is – it’s doubtful that even with the proposed debt restructuring Greece’s public debt is on a sustainable path, fiscal austerity is still bearing down on growth across Europe, more ratings downgrades are likely and monetary conditions are still too tight.
But the risk of a meltdown appears to have receded.
What’s more European business conditions indicators have picked up in the last two months.
In November, we referred to three scenarios for Europe:
1. Muddle through – i.e. a continuation of the last few years of occasional crises temporarily settled by last minute bare minimum policy responses.
2. Blow up – in which a financial crisis and deep recession see a break up of the euro.
3. Aggressive ECB monetisation – with quantitative easing heading off economic calamity, albeit not quickly enough to prevent a mild recession.
Recent action by the ECB appears to have reduced the chance of the “Blow up” scenario (probably to around 25%).
The costs of leaving the euro for countries like Greece (which would include a likely banking crisis as Greek citizens rushed to secure their current bank deposits, which are all in euros, and default on its public debt anyway) still exceed the likely benefits, so it still looks like the euro will hang together.
Overall, the most likely scenario appears to be some combination of “Muddle Through” but with more aggressive ECB action preventing it from spiralling into a “Blow up”.
The US – no double dip (again)
During the September quarter a big concern was that the US
economy would “double dip” back into recession.
This, along with escalating worries about Europe and the loss of America’s AAA sovereign rating, combined to produce sharp falls in share markets.
Since then, US economic data has turned around and surprised on the upside:
- Retail sales growth has hung in around 7% year on year despite a sharp fall in consumer confidence;
- Jobs growth has picked up;
- Housing related indicators have stabilised and in some cases started to improve; and
- GDP growth has picked up pace again after a mid-year softening.
Earlier concerns about a 1.5 to 2% of GDP fiscal contraction in 2012 dragging growth down have faded as Congress has agreed to extend payroll tax cuts and
