EIU Global Forecast: An Improved U.S. Outlook

Two opposing but related forces are driving the outlook for the global economy in 2014. On the one hand, the rich world's recovery continues (with intermittent setbacks) to be consolidated. Stronger performances in the US and the euro zone, in particular, will boost global GDP growth this year. On the other hand, volatility in financial markets—ironically triggered in part by the US policy response to improved conditions—is casting a pall on an otherwise promising outlook. Turbulence in emerging markets has increased. Nonetheless, The Economist Intelligence Unit continues to expect global GDP growth to accelerate to a four-year high in 2014.

Measured at market exchange rates, the global economy will expand by 2.9% in 2014, up from 2.1% last year. This would mark its best performance since 2010, a year in which growth was amplified by monetary and fiscal stimulus and by a rebound from the financial crisis and Great Recession. This forecast largely reflects positive developments in the advanced economies, which were hardest hit during the Great Recession and have taken the longest to bounce back. In particular, we have this month raised our forecast for US GDP growth in 2014. The US recovery is looking encouragingly broad-based, and has been buoyed by a combination of factors from consumer spending to healthy job creation.

The outlook also continues to improve in Europe, although conditions in many parts of the euro zone remain fragile. The currency union's six-quarter-long recession ended in the second quarter of 2013. Market interest rates have fallen in the weaker countries in the periphery, and many measures of business and consumer performance continue to improve. The UK is enjoying a surprisingly strong recovery, notwithstanding concerns about the sustainability of a debt-fuelled property boom. Japan, meanwhile, continues to benefit from the reflationary policy cocktail of "Abenomics", so nicknamed after the country's prime minister, Shinzo Abe. The US, the euro zone and Japan together will account for just under half of global output in 2014, and the prospect that these three huge economies will enjoy their first synchronised upturn since 2010 augurs well for global GDP growth.

The cyclical upswing in advanced economies will also be felt in the rest of the world. It will boost exports from emerging markets. Indeed, signs of improving trade flows were evident at the end of 2013. However, emerging markets have also felt the brunt of the shake-up in financial markets since January. Asset prices have been pushed lower by a number of factors, including the start of the US Federal Reserve's winding-down of its "quantitative easing" (QE3) bond-buying programme and some softer economic data. Another cause of the pressure on financial markets has been domestic trouble in the emerging economies themselves, especially political turmoil and poor policy choices in countries such as Turkey, Ukraine, Thailand and South Africa. This has left them unduly vulnerable to the inevitable pullback in global liquidity implied by the start of the Fed's exit from QE3.

While we expect further periodic sell-offs in developing markets during 2014, a sustained and widespread rout is by no means inevitable; the most serious problems are likely to afflict markets with specific political or economic weaknesses. Indeed, recent financial-market turbulence does not fundamentally alter our forecast for accelerating global economic growth in 2014, punctuated by periodic market pullbacks as the Fed unwinds QE3.

Developed world

There are few more powerful forces in the global economy than the US consumer, so recent official GDP data are encouraging. The economy grew by a brisk 3.2% in the fourth quarter at an annual rate, supported by the fastest increase in consumer spending in three years. Healthy levels of job creation, reductions in household debt and low interest rates have encouraged American consumers to open their wallets. As a result, we are increasing our real GDP growth forecast to 3% for the full year 2014, from 2.6% previously. There are risks to this brighter outlook, notably a housing slowdown and weak business investment, but the US economy is undeniably stronger than it has been for some years.

In the euro zone the sense of economic crisis has eased, as the threat of a break-up of the single currency has receded. Data for the second half of 2013 and the start of 2014 generally support our view that the recession is over and that the recovery—while tepid—is broadening. Many measures of business and consumer performance continue to improve, suggesting that the tentative economic recovery is gathering some momentum after a slowdown in real GDP growth during the third quarter. However, labour markets remain weak, especially in the euro zone's periphery. The recent return to economic growth will, ultimately, have a positive effect on household and business confidence, boosting consumer spending and investment, although deleveraging by banks in the periphery will remain a constraint. We forecast real GDP growth in the euro zone of 1.1% in 2014, picking up to an average of 1.4% a year in 2015-18.

In Japan Abenomics continues to have a generally positive impact on the economy. Mild inflationary pressures—welcomed in Japan, after many years of intermittent deflation—are looking more entrenched, and corporate profits remain strong. However, the approach of a planned rise in consumption tax in April introduces greater uncertainty to Japan's economic outlook in 2014, as it will affect data for both GDP growth and inflation. Indeed, we expect the tax rise to cause a quarter-on-quarter contraction in GDP in the second quarter of 2014. For the full year we forecast real GDP growth of 1.7%, the same rate as in 2013.

Emerging markets

Emerging markets have been under pressure as a result of a number of factors, including the US Fed's "tapering" of QE3, concerns about Chinese growth and the realisation that economic reforms in some countries have been neglected for too long. China's growth is edging lower and manufacturing has been softer than expected. We have accordingly edged down our forecast for 2014 real GDP growth in China to 7.2% from 7.3%. The authorities will continue to discourage excessive lending and over-investment in a bid to find a more stable rate of growth and rebalance the economy towards a higher level of consumer spending. India is poised to continue its recovery, following a couple of difficult years. We forecast GDP growth of 6% in fiscal year 2014/15 (April-March), up from rates of 4.9% and 3.3% in the two previous years.

The transition economies of eastern Europe experienced another difficult year in 2013. We estimate that GDP growth faded to 1.5% as a marked slowdown in Russia compounded still-weak conditions in east and central Europe. But a broad-based, if muted, improvement across the region is in prospect in 2014, provided that the current negative sentiment towards emerging markets does not endure. We forecast aggregate real GDP growth in the transition region of 3% in 2014, rising to 3.4% next year.

Latin America also struggled in 2013, with regional growth dampened by less favourable conditions on global capital markets and weak demand in Europe and China. Capital flight prompted by the US Fed's tapering of its bond-buying programme has intensified pressure on regional currencies, notably the Argentinian peso (although economic mismanagement made the currency especially vulnerable). However, most policymakers in the region may view a period of currency weakness as a welcome adjustment. Although the tone of recent economic data remains weak, we maintain our forecast that growth in Latin America will accelerate to 3.2% in 2014, lifted by stronger global growth.

Political instability will continue to hamper economic performance in the Middle East and North Africa (MENA), three years after the start of the Arab Spring. The deepening civil war in Syria will drag on, leading to permanent economic damage and potential fracturing of the country. Moreover, the war in Syria will act as a crucible for regional sectarian violence and has sparked a heightened round of violence in both Iraq and Lebanon. Economic performance in MENA as a whole will nonetheless improve in 2014-15 as Iran, among the largest regional economies, returns to growth after two years of contraction caused by a decline in oil production and international sanctions. Heavy capital expenditure among Gulf countries will also continue to propel regional growth rates upwards as infrastructure and industrial spending continues.

Despite a challenging external backdrop, we expect Sub-Saharan African growth to accelerate in 2014-15. However, performance will vary substantially across subregions and individual states. Countries affected by political unrest or potentially contentious elections could register expansion of less than 2.5%, or even contraction. On the positive side, the strong investment of recent years in the extractive industries will see commodity production continue to rise strongly—although the growth of unconventional oil and gas production in the US is likely to have an adverse effect on the West African hydrocarbons sector. More broadly, regional GDP growth in the next few years will be buoyed by much-needed infrastructure spending and by the expansion of the lower middle class. We forecast real GDP growth of 4.5% in 2014, rising to 5.7% by 2017.

Exchange rates

A variety of external and internal stresses pushed down the value of many emerging-market currencies against the US dollar in January, leading to fears of a broad sell-off. Although most of these currencies recovered modestly in early February, downward pressures are likely to re-emerge periodically throughout 2014. While the recent depreciations in emerging markets have been painful for some countries, they arguably represent a necessary adjustment that will help to restore competitiveness lost as a result of the large capital flows that poured into these markets. We continue to stress that an actual rise in the Fed's official policy rate will not happen until late 2015 at the earliest; this long lag will also reduce the likelihood of a shock to emerging-market currencies. The fact that US monetary policy is moving out of its ultra-loose posture into a tightening phase means that the US dollar should, over time, rise against major currencies such as the euro, where the single-currency bloc is growing slowly, and against the yen as the Bank of Japan pursues its own bond-buying programme. In this context we forecast that the dollar will strengthen against the euro to an average annual rate of US$1.29:€1 in 2014, from US$1.33:€1 last year.

Commodities

Commodity markets weakened in 2013, reflecting concerns about the economic slowdown in China and the prospect of the US Fed's taper (commodity markets are perceived to be beneficiaries of the liquidity generated by QE). Our current forecasts suggest that industrial raw materials prices will pick up slightly in 2014 as economic recoveries take hold, particularly in the developed world. Agricultural commodity prices will show another year of decline, owing to a healthy supply picture and large stocks. On the energy front, oil supply will recover strongly in 2014, boosted by robust growth in non-OPEC production. We therefore still expect a modest easing of prices despite a slightly better demand picture. A barrel of Brent will cost an average of US$105.5 this year, down from US$108.9 in 2013.

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