Global Economic Outlook : All Quiet on the Western Front

After years of gloomy forecasts, we finally see a new year with no thunderclouds on the horizon. Growth is likely to pick up in most economies, but not enough to stoke higher inflation. All in all, the outlook appears to be more balanced and better than it has been in years. 

Our view 

And now for something completely different : Our recent year-ahead pieces have made for depressing reading, all the more so since the pessimistic projections proved to be largely on target. The coming year is different, with no obvious threat in the near future – no Fiscal Cliff, no European debt crisis. Instead, global growth is likely to accelerate back to trend, with inflation remaining low. While the Federal Reserve is likely to end its policy of quantitative easing, policy rates across the world should be essentially flat. 

Out of rehab in the U. S. : Monetary policy has healed many of the wounds of the financial crisis. Balance sheet repair is now well advanced : The federal budget deficit has fallen from 10% to 4% of Gross Domestic Product (GDP) ; banks are recapitalized and working off bad loans ; the housing market has started to recover ; corporations are flush with profits and cash ; and households have reduced their debt service costs. At the same time, it appears that there will be no additional fiscal austerity at the federal level, and state and local governments have stopped budget-cutting. As structural headwinds fade, we expect GDP growth to accelerate from an average of 2. 2% in the last four years to 2. 6% in 2014 and 3. 2% in 2015. 

More muddling through in the Euro zone : We expect growth in Europe to remain low. In our view, policymakers amplified the acute phase of the European crisis, but forbearance now seems to be the name of the game, with peripheral countries being given more time to chip away at their budget problems. The European Central Bank probably will introduce a new long-term refinancing operation, but – influenced by the Bundesbank – is otherwise likely to refrain from significant easing. This is not likely to mean strong growth : Credit and fiscal policy remain tight, confidence is weak and the economy muddles along. We see timid recovery of 0. 8% GDP growth, driven mostly by exports and less fiscal drag. 

But a better outlook for the rest of the world : Abenomics should deliver another year of 2% growth in Japan, with a combination of a weak currency and better growth ending deflation and pushing core Consumer Prices Index (CPI) inflation up to 0. 9%, even excluding the impact of a higher consumption tax rate. China’s GDP growth is likely to moderate from 7. 7% in 2013 to 7. 6% in 2014. Emerging markets growth should pick up modestly, pulled along by better growth in the developed world and a continued re-engagement of global manufacturing and trade. 

Key calls 

Inflation : Continued stability ahead. After surging in 2011 during a period of rising commodity prices and booming emerging markets, inflation has fallen in almost every country, with the exception of few countries facing foreign exchange-fueled price increases, such as the BIITs – Brazil, India, Indonesia and Turkey. Japan also has higher inflation, the product of its weak currency policy. But, on the whole, global inflation should remain at close to 3% next year. 

Monetary policy : Tapering tap dance. With inflation low, central bank monetary policy is likely to be mixed. The Federal Reserve is likely to very slowly exit quantitative easing, while keeping interest rates low for a longer period. The Bank of Japan is likely to continue its embrace of aggressive Fed-style easing to reinforce the Yen’s weakness and offset any downside risks from next April’s tax hike. In between will be the European Central Bank (ECB), which is likely to ease liquidity through another long-term refinancing operation but without the aggressiveness of either Japan or the U. S. 

Risks : The usual suspects. The downside risks to growth do not appear to be particularly high in 2014, and there are also upside risks. The downside risks include the usual suspects – brinksmanship in U. S. fiscal policy, political events in Europe that could restart its financial crisis, an oil shock if the Iranian nuclear control talks break down or if the Japanese government fails to offset its consumption tax hike with other policies. However, there also are upside risks, ranging from a stronger cyclical bounce in the U. S. as headwinds fade to a faster recovery in emerging markets as deleveraging slows and bank lending picks up. All in all, the outlook appears balanced and better than in the recent past.