Global economic environment

The global economy has been on the road to recovery since the third quarter of 2009, buoyed by an array of fiscal and monetary stimulus packages. Manufacturing is benefiting most from the reversal in the inventory cycle and rising demand. In contrast, surveys suggest a hesitant rebound in services. Following an unprecedented 2.2% contraction in GDP in 2009, the consensus estimate of world growth this year is 3%. Growth in developed countries is expected to be soft in historical terms, at 2.9% in the USA, 1.5% in the UK and 1.3% in the euro zone and Japan. The outlook for European activity is undermined by prolonged recession in its smaller economies (Greece, Spain, Ireland) and disappointment in the UK, where GDP rose only marginally in Q4, as well as in Germany, where manufacturing output has contracted in line with faltering orders and GDP was unchanged in Q4. Developed countries will not renew with their pre-crisis growth rates in the foreseeable future.

Greece’s public finances are a major headache for the government, which has been forced into drastic, unpopular but inevitable fiscal consolidation. In our view, it would be unthinkable for adjustment to involve Greece’s expulsion from the euro zone and letting the government default. The stakes for the euro zone could hardly be higher, both in terms of credibility and in terms of cohesion. Everything possible will be done to calm the situation and prevent the crisis taking durable hold of Spain and Portugal as well. The Greek government’s austerity programme has been approved by the European Commission, which will monitor progress on both spending and receipts. Greece will also report on its finances every quarter.

In emerging economies, robust domestic demand will ensure rapid growth over the next two years. Emerging Asia will remain the most dynamic region, with GDP projected to expand 7.8% in 2010. Driven by an upswing in international trade, industrial activity has already returned to its pre-crisis levels. Because of its lead in the recovery cycle, Asia will report slightly slower growth in 2011 (7.4%). Growth forecasts for Latin America are 3.8% for both 2010 and 2011; Brazil will lead the way with 5.4% this year. Emerging Europe will lag these regions, and although its GDP is set to rise 3% this year there will be marked disparities between countries.

Monetary tightening has started in the countries at the most advanced stage of the recovery cycle – Australia and Norway – and it will continue. In the USA and the euro zone, the first rate hikes will not come until late 2010 or early 2011. At its February monetary policy meeting, the ECB’s Governing Council announced the gradual withdrawal of unconventional measures via reductions in the frequency and term of open market operations. In the UK, and because of fears of inflation, the Bank of England could raise rates in Q3 or Q4, while in Japan the authorities will leave their rates unchanged over the next 12 months in a context of falling prices.

In emerging Asian and Latin American countries, the first rate hikes are in the pipeline (Colombia, Brazil, India, the Philippines and South Korea) but they will be limited to 25bp overall. Over the coming 12 months, Brazil and Chile will hike their policy rates by 250bp and India by 125bp. In Eastern Europe, the outlook for growth means that no hikes are expected in the near term. For Hungary and Russia, which were slow to ease monetary policy during the crisis, 50bp rate cuts are projected soon (and a total 100bp in Russia over 12 months). We would not rule out the possibility that renewed inflation risk in Asia in conjunction with rapid economic growth could prompt local central banks to tighten earlier and by more than forecast so far.