Author: Robin Bew

Location: London

Date: 2013-01-14

Stronger global GDP growth. The global economy will remain weak, but some improvement is in prospect. The downturn in the euro zone will ease, with the 17-country bloc likely to return to very weak year-on-year growth in late 2013. Recent stimulus in China should feed through more visibly during the year, with Chinese growth accelerating to an annual average of about 8.5%—although it should be noted that this will be a peak for the current cycle and is unlikely to be matched again given the slowdown in China's trend growth rate. Congress's January 1st mini-deal on the "fiscal cliff" removed an immediate threat to US growth prospects, but how the world's biggest economy performs in 2013 will depend on the extent to which the next few months are marred by similar fiscal policy showdowns. The key downside risk to our forecasts will remain the possibility of further financial upheaval in the euro zone. But upside risks are arguably strengthening, in particular over the timing of the modest global recovery, which could gather pace sooner than we expect if confidence returns.

Relative calm in the euro zone? We expect plenty more ups and downs in efforts to contain and, ultimately, resolve the debt crisis in the euro zone, but the picture has brightened since mid-2012. The European Central Bank's commitment in principle to unlimited sovereign debt purchases has calmed financial markets. Italian and Spanish sovereign bond yields have fallen to much more sustainable levels compared with late 2011 and mid-2012. The single currency's crisis seems to have entered a less acute phase, in which concerns about austerity, slow growth and a lack of competitiveness are starting to replace fears of sovereign default and financial-market implosion. That said, the fundamentals of the debt crisis are far from resolved, and worries about France—something of a laggard in owning up to the severity of its fiscal challenges—could come to the fore this year. Events—from the Italian general election to political unrest in Greece—still have the potential to trigger a crisis, but 2013 could well be a year in which the euro zone's problems largely rumble on.

 

More fiscal brinksmanship in the US. If the world breathed a sigh of relief when US lawmakers struck a deal on January 1st 2013 to prevent/delay implementation of assorted fiscal tightening that could have sent the US into recession, the risks of a self-inflicted economic downturn have not disappeared. A grand bargain over the country's long-term fiscal challenges has eluded Democrats and Republicans, and the fiscal cliff mini-deal was disappointingly modest in scope. The legislation preserves some tax breaks and extends unemployment benefits but has deferred any decision on government spending cuts. This sets the US up for repeated bouts of political wrangling over fiscal policy during 2013. In particular, partisan brinksmanship will complicate negotiations over the raising of the US federal debt ceiling (which will probably be necessary in late February). All this bodes ill for economic policymaking during the year, and could hurt consumer and business sentiment—although markets and firms have become more resilient.

An extension of the risk asset rally. Quantitative easing (QE) in the US and elsewhere, combined with a slackening of financial tensions in the euro zone periphery, has fuelled a rally in risk assets in the past few months. The rally has a decent chance of continuing in 2013, as the ultra-low interest-rate environment in the developed world will encourage investors to seek higher yields in riskier assets such as equities, commodities and corporate bonds. That investors are still moving into risk assets is visible in higher yields on the traditional safe havens of US and German government bonds. Although still very low by historical standards—indicating continued investor caution—US 10-year yields were at 1.92% on January 7th, around 50 basis points up from July 2012. German yields are up by a similar amount from their June 2012 lows. For many investors, the search for yield may override valuation fundamentals, which could be a source of longer-term financial risk when markets eventually normalise.

A Japanese reflation agenda. The election of Shinzo Abe as Japan's prime minister in December 2012 has potential repercussions that extend well beyond the domestic economy. One of Mr Abe's main policy goals is to end the deflationary pressures that have long dogged Japan, and thereby to create conditions for self-sustaining economic growth. As part of this agenda, we expect Mr Abe to push aggressively for the Bank of Japan to raise its inflation target from 1% to 2% and to commit to unorthodox monetary easing on a much greater scale—both to stimulate domestic demand and to counter the deflationary impact on Japan of QE elsewhere. The success or failure of these efforts could have implications for global exchange rates, and the policies could create international trade tensions if perceived by Japan's trading partners as an attempt artificially to support Japanese exports. Yet Japan's poor demographics and other fundamentals mean that Mr Abe's stimulus measures may fail to gain traction. At the same time, the prime minister's agenda raises the prospect of increasing political interference with the central bank.

A higher profile for structural reform. In the coming year policymaking may take a longer-term view. Emergency measures were necessary in 2008-09 to prevent collapse of the global financial system and in 2010-12 to prevent a possible fracturing of the euro zone. Major risks to the integrity of the euro remain. Nonetheless, just as global financial policymaking is now focusing on systemic protection against future crises—albeit with uneven results, for example in banking regulation—in the euro zone questions of long-term competitiveness and structural reform are gaining a higher profile. Provided that further acute bouts of financial contagion can be avoided, issues such as the need to lower unit labour costs, liberalise services markets and create better conditions for innovation and sustainable growth will gain prominence. The reform focus will be echoed in parts of the emerging world—most notably in Brazil, where policymakers are having to come to terms with the country's post-2010 slowdown and address long-standing needs for greater flexibility in the economy.

Austerity. Fiscal tightening will continue to constrain growth and dominate the public debate in many countries in 2013. Most obviously, it will remain a central economic and political issue in the EU, in part because of the severe fiscal consolidation still under way. Our budget-balance forecasts indicate that 20 out of the EU's 27 member countries will experience fiscal tightening in 2013, which in many cases will come on top of a prior year of such hardship in 2012. In the UK, austerity will remain a source of tension between the two partners in the coalition government. In a number of countries in Europe, the social and political pressures that have emerged as a result of austerity will continue to fuel hostility towards immigrants and ethnic minorities. In the US, austerity will not bite as deeply or cause as severe social stresses, but the debate about fiscal sustainability will be intense and highly politicised. More broadly, in many countries a combination of weak or negative growth and a lack of fiscal resources will limit policy options.

Political changes. 2013 looks set to be relatively quiet year for major elections, but a number of forthcoming and ongoing political changes will still bear watching. Some of these will be the result of transitions that commenced in 2012. As discussed above, the change of government in Japan has potentially far-reaching economic policy consequences. China, meanwhile, is still in the early stages of a once-in-a-decade transition to a new political leadership. Economic challenges facing the new leadership (the members of which will be further formalised at a government conclave in March) include planning structural reforms to anticipate the erosion of China's advantages as a low-cost export manufacturer. In Europe, general elections in Italy (in February) and Germany (in September) will be important for those countries' continued policy responses to the euro debt crisis.

Robin Bew is the Chief Economist for the Economist Intelligence Unit.

 

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