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Monday September 18, 2006 - 10:56:45 GMT
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Economics Weekly: Global growth proves remarkably resilient

Economics Weekly 18 September 2006
Global growth proves remarkably resilient

World economy is robust
With the IMF just releasing its second set of 2006 economic forecasts (timed for October), this seems like a good time to assess its latest global economic forecast compared with those it made in April. Despite all of the challenges that the world economy has faced this year, from higher oil prices to renewed conflict in the Middle East, global economic growth has been revised higher. Moreover, this is not just for growth in 2006 but next year as well. We assess the reasons for this in this week’s economic briefing.

Growth proves resilient…
Figures just released from the IMF show it now expects world economic growth - adjusted for inflation differences - to be 5.1% this year, up from its projection of 4.8% in April 2006. The IMF has also revised up its growth expectations for 2007, by 0.2% to 4.9% annual growth. This would represent the fourth consecutive year in which global economic expansion has been around 5%, the best performance since the early 1960s and 1970s, when the global economy was subsequently hit by a massive wave of inflation that lasted until the early 1990s. This is particularly remarkable given the record high level that nominal oil prices reached this year and the volatility of the US dollar, acts of terrorism and continued war in the Middle East and Afghanistan. So what has prolonged growth in this global economic cycle?

…as the emerging market economies grow rapidly...
A clue can be found in chart a, which shows the growth of the global economy split between developed and developing countries. It is clear from this chart that the emerging economies have been growing nearly three times as fast as the developed economies since 2000. Hence, it is globalisation - the growing integration of the world economy - and the economic forces that this has unleashed that is giving the emerging markets the impetus to grow as quickly as they are. One of the key reasons why globalisation is occurring is down to recognition by previously closed economies and societies that the best and fastest way to prosperity is through joining the market economy. It is clear that this process is virtually unstoppable, though facing a big threat from protectionism if losers in the process are not compensated by the winners. This is the main risk to a continuation of growth in the years ahead, but not, in our view, to prospects for economic growth in 2007.

…offsetting a slowdown in the US
Chart b illustrates that despite a slowdown in the US in 2007, global growth is still strong as growth in the emerging market economies offsets a slowing US. Growth will be particularly fast in the largest emerging economies of China, India and Russia but, as chart c shows, fast expansion in the emerging markets is not confined to them.

Risks to growth remain…
But there are still risks to global economic growth in 2007. The very fact of the growing importance of the emerging markets, for example, makes the risk of a political or other crisis in China, India and Russia even more dangerous for the world economy. Commodity prices are likely to fall and that could hit the growth rate of the commodity intensive emerging market economies. Oil prices are presently close to $60 a barrel, down from a high of around $80 - helpful to overall global economic growth but damaging to growth in the oil exporting countries like Russia. Moreover, there are still risks from the US slowdown turning into something more pronounced, if the housing market collapses. Though it has to be said that this has not been the experience of Australia and the UK, which are ahead of the US in their house price cycle and where house prices though correcting somewhat have not crashed and are currently rising again. Other risks stem from global imbalances and the somewhat shaky prospects for sustained growth in Europe and Japan. Nevertheless, we agree with the IMF that global growth prospects look bright for the remainder of 2006 and for 2007.

However, charts e and f show that inflation has risen alongside growth, prompting a rise in short term official interest rates to curb growth and inflation. This will surely lead to slower growth in 2007 as well. One question is whether bond yields, shown in chart g, are too sanguine about the prospects for a return to low inflation next year in the context of faster global growth and higher inflation this year.

Commentary on economic data in the week

The US interest rate decision on Wednesday dominates the events calendar this week despite a strong consensus that rates will stay on hold
• • Recent US economic data have provided mixed signals and it still appears too early to call the peak in interest rates in this tightening cycle. However, the probability of a hike this week is considered very small in our opinion.
• • Although it was widely expected that the Bank of England would refrain from raising interest rates two months in succession - after a surprise 25bp hike in August - the minutes of the 6-7 September MPC meeting, due on Wednesday, will be dissected for clues about interest rate prospects in the months ahead.
• • Relatively few key economic data are due to be released this week. The highlights are US Q2 current account balance and July capital flows data on Monday and August housing starts on Tuesday. In the UK, there is a flurry of releases on Wednesday, headed up by the first figures for mortgage lending in August.
• • Market-moving news from the EU-12 appears limited but the ZEW survey on Tuesday may surprise.

After 17 consecutive 0.25% hikes at FOMC meetings starting in June 2004, the US central bank kept interest rates on hold at 5.25% at the August meeting. The jury is still out as to whether this will prove the peak in the current monetary tightening cycle. Recent inflation data have shown that price pressures in the US remain significant and that economic growth may not slow enough to sufficiently dampen inflation from its current elevated level. Annual core CPI in August was 2.8%, well above the Fed's 2% comfort level. However, interest rates are strongly expected to remain unchanged on Wednesday and interest rate futures are increasingly suggesting that this may remain the case for the remainder of 2006. We see a pause this week, but look for one more 0.25% hike later this year to take rates to 5.5%. The US Q2 current account, on Monday, could show another deficit above $200bn but may be overshadowed by capital flows data for July later that day. If both are poor, this could weigh on the dollar, despite the current focus on interest rates. Housing market data on Tuesday are expected to show a further fall in activity in August, albeit from historically high levels.

UK economic data this week are bunched up on a busy Wednesday and may be overshadowed by the release of the minutes of the 6-7 September Bank of England MPC meeting. The committee may have had prior knowledge that CPI annual inflation accelerated to 2.5% in August, however the minutes are strongly expected to reveal a unanimous vote for unchanged interest rates in September. A different result could have implications for financial markets. We believe interest rates will be raised by 0.25% to 5% in November and possibly to 5.25% in Q1 2007, depending on where CPI peaks this year. The impact of the interest rate rise in August on mortgage lending will be assessed from BBA and CML data for that month released at the same time as the MPC minutes. Public sector finances data provided a fillip for the Chancellor in July and figures for August could re-assert that he is back on track to meet his 06/07 borrowing target in the March Budget. But government borrowing still looks too high and needs to be cut. August money supply growth will attract less market attention but will remain near decade highs and warns of medium-term inflationary pressure. The CBI Industrial trends survey, on Thursday, could show the key index improved to -4 in September.

Economic news from the euro zone is limited this week and may leave prospects for the euro and bond markets to be dictated largely by events elsewhere. The highlight is possibly the German ZEW survey of financial analysts perceptions on Tuesday, which surprisingly fell to a 5-year low in August on concerns about growth. There is a risk of a further fall in September.

Rapid economic growth is also occurring in Central and Eastern Europe, the Middle East, Latin America and Africa. All these regions are growing faster than the developed economies. Part of the reason for this is that rapid global growth in the emerging giants has led to a vast increase in demand for resources, not only energy but also grains and metals. In fact, China, India, Brazil and Russia only account for some two-fifths of emerging countries output. This demonstrates that globalisation is not a zero sum game; everyone can benefit, though only if the right policies are adopted. The biggest losers are those countries that do not participate in the global economy.

Trevor Williams, Chief Economist
[email protected]
Lloyds TSB Bank,
Financial Markets
Faryners House,
25 Monument,
London EC3R 8BQ
0207 283 - 1000

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