Economic Mentality is Party Now, Pay Later

FROM THE ECONOMIST INTELLIGENCE UNIT

Global economic growth will accelerate markedly this year, compared with 2005’s performance, supported by stronger-than-expected performance in the US, Japan and the euro area. However, this will come at the cost of a sharper slowdown in 2007, as the US enters a cyclical downturn and the European recovery is checked. At the same time, high oil prices will continue to take a toll: in annual average terms, we now expect virtually no price softening in 2006 or 2007.

The Economist Intelligence Unit has just produced a regular update of its global assumptions. The September highlights are as follows:

• Recent data confirm that 2006 as a whole is looking more like 2004 than 2005, with growth now set to accelerate to 5.3% (weighted using PPP exchange rates), from 4.9% last year. This is also reflected in the new forecast for world trade growth, which is expected to hit 9.3% (against a previous forecast of 8.8%). These forecasts, however, hide a global slowdown that is now in its early stages in certain parts of the developed world. This will show up mainly in projections for 2007, with the world economy now expected to expand by 4.7% (previously 4.8%) in that year. The risks to this rather benign outlook are on the rise, however.
   
• The business cycle in the US has already hit its peak, and growth there is slowing significantly. We have revised downward our forecast for US growth in 2007 to 2.2% (previously 2.4%). Although it is not our baseline projection, we do not rule out one or even two quarters of contraction, driven by a retrenchment of private-sector demand in response to higher borrowing costs and fuel prices as well as a sharp cooling of the housing market. While we expect the Federal Reserve (central bank) to raise its base interest rate by 25 basis points (bps) one more time before the end of the year, increasingly it is looking like the two-year monetary-policy tightening cycle may be is at an end. We forecast that the Federal Reserve will cut rates by 50bps in 2007.
   
• We have revised our forecast for real GDP growth in the euro area to 2.3% (previously 2.1%). Recent data for the second quarter reveal that economic expansion was stronger than expected, leading us to hike our growth projections for several of the euro-zone economies. We still expect growth in the euro area to decelerate to 1.9% next year, as consumer demand in Germany is hit by an increase in the value-added tax rate and the region as a whole suffers from a weaker external environment.
   
• Based on recently released data, we have revised downwards our forecast for Japan's growth to 2.8% (previously 3.1%). Exports were much weaker than expected in the second quarter, although consumer demand and business investment remained quite strong. We have thus made a slight upwards revision to our growth forecast for 2007, to 2.2% (previously 2%).
   
• Perhaps more importantly for the world economy, our forecasts for Japanese interest rates have changed significantly. Rapidly rising corporate-goods prices, rising import prices and the above-mentioned strength of the domestic economy lead us to believe that the Bank of Japan will raise rates more aggressively in 2007, with the target for the overnight call rate rising to perhaps 2% by the end of that year.
   
• We have revised upwards our forecast for average oil prices in 2007, with the price for Brent crude to stay above US$70/barrel for longer than we had been projecting earlier in the year. The price for Brent will now average US$70/b (previously US$66/b) in 2007, essentially the same as our expectations for 2006 as whole (US$71/b). We expect spare capacity to remain tight this year and next, especially as demand from China remains exceptionally strong. In this environment geopolitical risks play an important role at the margins, and we do not expect the associated risk premium to fall by much, if at all, over the next 16 months.

Whilst every effort has been taken to verify the accuracy of this information, The Economist Intelligence Unit Ltd. (http://www.eiu.com/) cannot accept any responsibility of liability for reliance by any person on this information.