Australia | Mar 22 2013
-The US to drive the global recovery
– Europe to improve
– China to firm
– Italy not that big a risk
By Andrew Nelson
The global economy is finally on the road to full recovery, with positive conditions only accelerating over the years ahead. That’s something you have probably wanted to read for quite a while now and what’s even better, this is the admittedly qualified opinion of economists at Danish financial house Danske Bank.
Danske expects the euro area will remain in difficult circumstance for a little while longer, but it should also see a gradual return to slow, but at least positive, growth sometime reasonably soon. China, too, is starting to step on the pedal again, with signs the gradual slowing over the past couple of years is coming to an end.
The problem with the China story is not that the economy isn’t recovering, but that it is recovering to what will be a re-based growth rate that is lower than before the slowdown. Danske also expects Japan will rebound this year too on the back of Abenomics, but there still remain some dire risks for Japan in 2014, say the economists.
Thus China and/or Asia won’t be driving the recovery, neither will emerging markets be providing the main motive force as has been the case over the past few years and Europe, while recovering, will only be of limited use. Sure these regions will help and also assist in shaping the size and ultimate velocity of the recovery, but they won’t be sitting in the driver’s seat.
Pushing this recovery forward will be the economy that has almost always sat in the global driver’s seat over the past century, the United States. Because, says Danske, 2013 will be the year the US economy really takes off. The bank notes fundamentals in the private sector are improving, the housing market is showing some steady, if not yet healthy, signs of life and the business caution of the last few years has generated a significant level of pent-up demand for investments.
Sure, there will be intermittent bouts of fiscal contraction and these will undoubtedly weigh on growth, but any fiscal drag will be no greater than last year and this year the fundamentals are looking way better, says Danske.
This is all before we get to the real power plant of the US economy, the US consumer. In the short term, Danske expects US consumers will remain on the sidelines a little longer as the tax hikes and lower government assistance levels implied by the failure of the sequester start to flow through. Still, Danske expects this will only have a temporary impact, with the underlying growth recovery theme remaining intact.
This should take us out to the end of 2013 and at that point we should see consumers really chiming in. The Danish bank is expecting to see improvement in the labour market in the next few quarters, which should allow the Fed to begin relaxing the pace of balance sheet expansion by the December quarter this year. This would mark the official turning point after which the Fed may start thinking about rate rises again. Although, Danske doesn’t expect the Fed to start lifting rates any time before March quarter 2015.
At the same time, the Bank of Japan is stepping up asset purchases and Bank of England is expected to do so, while Danske expects the European Central Bank (ECB) to keep rates low for a very long time. This will of course lend support to the US effort.
The main risk to this playing out comes from the Old Countries, with a renewed flare-up of the euro crisis not only possible, but easily imagined. Something as innocent as a slowdown in Germany, or France, could light the fuse, although it’s more likely to be ignited by financial chaos in Italy, Spain, or hey, even Cyprus.
But to be fair, the ECB has put in a back-stop that Danske thinks will keep the plates from at least sliding off the table. And if we’re honest, the fiscal situation has improved somewhat in the broader euro area after what have been a few years of consolidation.
Danske thinks the most likely European implosion story that could hurl the recovery off the tracks is Italy. The current political situation is in a state of flux. There is no government and the economic outlook worsens every day, which means bond yields keep creeping higher. It is almost unthinkable to the bank that Italy won’t have to come cap in hand for money, although at the moment the populist politicians are dead against it.
Then it all blows up and we’re right back to where we were with the Greece thing, only ten times worse because Italy is an actual economy. Danske thinks an Italian crash could cause a substantial widening of peripheral sovereign spreads and in turn, a 10%-15% correction in global stock markets on the revival of eurozone break up fears.
But Danske’s crystal ball tells it that this would then force Italy to sit down with the European Stability Mechanism (ESM) and the ECB to take advantage of the Outright Monetary Transactions (OMT) program. Italy then steadies the ship, there is renewed optimism in financial markets and we’re back to the good news story above.
Lastly, the Danish bank also sees scope for an even stronger than expected US recovery on a big rebound in the housing market and more generally, on decreasing levels of uncertainty. This would in turn release the flood gates on some very high levels of pent-up demand. Such an outcome could trigger a positive feedback loop pushing US growth rates to upwards of 4%-5%. If that happens, then BOOM goes the global economy.
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