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THE YEAR AHEAD 2015

(Auspacific Bulletin)

The year ahead will see increasingly growth divergent growth trends in the major world economies, for example the USA economy and the economy of the United Kingdom are evidencing growth due to improving labour markets accompanied by continued accommodative monetary policy. However growth in the Euro Zone and Japan has not improved due to the legacy of the financial crisis lasting longer intertwined with structural bottlenecks. In China we are seeing a carefully managed slowdown taking place.

There has also been disappointing growth in developing countries in 2014 due to weak demand and the tightening of domestic policies, political uncertainties and supply side constraints.

Global Outlook

The recent World Bank Report (January 2015) expects a moderate increase in global growth to around 3.9 percent in 2015 with an average of growth to come in at around 3.3 percent into 2017. The growth for developed countries is anticipated to be around 2.2 percent in the period 2015-17 which is up from 1.8 percent in 2014 coming from a recovery in the labour markets, an ebbing of financial consolidation and continued low costs of finance.

In the developing countries there should be an easing of the domestic headwinds that held back growth in 2014 and as the recovery in high-income countries gathers pace the growth is projected to rise from 4.4 percent in 2014 to 4.8 percent in 2015 and up to 5.4 percent in 2017.  The lower oil prices should provide diverging prospects for oil exporting and oil importing countries, especially in 2015.

Risks

These are tilted to the downside, the borrowing capacity could sharply raise developing countries borrowing costs and a subsequent deterioration in liquidity. This would be quite unwelcome where there has been several years of heavy capital market issuance in developing countries. Other factors may be intensifying geopolitical tensions, bouts of volatility in commodity markets, or financial stress in a major emerging markets leading to further assessment of risk assets.  There could be a further weakening also of global trade if the Euro Area or Japan were to slip into prolonged periods of stagnation or deflation. There is also the possibility (given a low probability) that China experience s sharper decline in growth and this could possible trigger a disorderly unwinding of financial vulnerabilities and this could in turn impact on the  world economy (particularly Australia).

At this stage of growth and recovery there are significant policy challenges

High Income Countries: There continues to be a need for continued accommodative monetary policy as the recovery remains fragile.  There is also a need for flexible fiscal policy to support growth but it needs to be accompanied by concrete medium consolidation plans and structural reform

Developing Countries:  In some counties the impact of global financial tightening may result in capital flows and currency depreciations. This may result in a weigh up on monetary policy measures so as to support current account adjustments which could weaken balance sheets and dampen the disinflationary effects of soft commodity prices.

United States of America

In 2014 growth in the US economy reached 2.6 percent (World Bank Report January 2015), driven by robust housing markets and credit expansion. Into 2016 growth is expected to stay at least at these levels in spite of weaker exports resulting from weak demand in the euro block. This recovery of the economy has come through a highly accommodative monetary policy that has boosted capital market valuations and an easing of fiscal consolidation. Labour markets have improved and have been marked by robust job creation and a modest increase in wages. It must be noted however that although unemployment has fallen sharply actual labour force deterioration has declined to levels not seen since the early 1980’s, at that time female participation was much smaller. Inflation is expected to remain below target in 2015-16 partly due to sharply lower oil prices and a strengthening US dollar.  It is expected that monetary tightening will occur around mid 2015 as the slack in the economy diminishes.

United Kingdom

Growth reached 2.6 percent in 2014 (World Bank Report January 2015), and is expected to stay at these levels until 2016. As the recovery broadens, supported by low oil prices it is expected the Bank of England will begin modest tightening of monetary policy in the second half of 2015.  Any delays to this could come from spill overs from the weak activity in Europe, low inflation and subdued wages growth.

The Euro Area

Overall activity in the Euro Area has been weaker than was anticipated, particularly in France, Italy and Germany. Reasons have been long term prospects concerns, legacies of the past (impaired balance sheets and high unemployment) which have weighted on a fragile recovery. Greece continues with political uncertainty which impacts on investor confidence. Ireland and Spain however have improving economies helped by competitiveness and strengthening corporate balance sheets. The Euro area should also have lower headline inflation due to the drop in oil prices.

Japan

Following the sales tax increase in April 2014 the economy fell significantly short of expectations reflected in a falling of growth by 0.2 percent for 2014 and this was in spite of a weak Yen. The global situation has impacted substantially on Japanese exports, at the same time there has been relocation of production facilities outside Japan accompanied by higher energy costs following the shutdown of the nuclear reactors.  Positives for the Japanese economy include, softer oil prices which should reduce energy costs, low unemployment’s as the labour force participation remains below pre-crisis levels and real growth is subdued. The World Bank January 2015 report states growth reaching 1.2 percent in 2015 and 1.6 percent in 2016. In 2017 it may decelerate to 1.2 percent as a second sales tax hike is implemented.

China

The Chinese have moved to implemented measures that are aimed at containing financial vulnerabilities and unwinding excess capacity (including construction, shipping and renewable energy sectors) but at the same time stemming a slowdown. The real estate market has also been slowed as credit has been reigned and in turn this dampened investment and growth in 2014.  The authorities have now implemented a series of targeted stimulus measures that include support for new public infrastructure and housing projects, tax relief to small and medium sized business and targeted cuts in the banks required reserves. In November 2014 benchmark deposit and lending rates were cut, this has not happened since 2012. Inflation is expected to remain below the central banks indicative ceiling of 3 percent reflecting excess capacity, weakening domestic demand, and reduced import costs.

In summary the major economies are expected to shape 2015 for developing countries, why?

1.            Monetary Policy tightening in the USA, combined with continued accommodative policies in the Euro Area and Japan should be reflected in modestly tighter financing conditions for 2015-16

2.            As commodity prices have fallen on expanding supply and concerns about global growth, they are expected to remain soft

3.            The anaemic recovery in the Euro Area and Japan continues which accounts for almost one third of global imports and a subsequent weighing on global trade growth.

Source : Selected data from the World Bank Report January 2015 and relevant country authorities.

John Brooks

TRADE ECONOMIST

THE AUSPACIFIC INSTITUTE

20 January 2015