FYI | Nov 14 2011
By Greg Peel
“The risks to the global economy are still significant,” suggests Danske Bank, “with the main risk coming from a sharp worsening of the euro crisis”.
Danske is not exactly lonely in this opinion, and “sharp worsening” is made ever more possible as Italy's bond yields reach levels that shout “default!” But the Danske economists “expect the fire fighting to continue for a long time,” anyway “as the euro area stays close to the brink of large-scale turmoil”. Most importantly, Danske simply believes the eurozone will not be allowed to “fall over the cliff” but that the EU and ECB will do whatever is necessary.
As to expectations Europe's economy will fall into recession, well you won't get an argument out of Danske. Unsurprisingly, eurozone leading economic indicators have now turned sharply sour and Danske has pulled back its 2012 growth forecast to a mere 0.3% from an earlier 1.1%. The economists' 2011 forecast remains at 1.6% but the bridge from 2011 into 2012 will mean negative growth in the fourth (-0.3%) and first (-0.1%) quarters – technical recession.
The eurozone's purchasing manager's indices (manufacturing, services) have fallen sharply in recent months, Danske notes, and retail sales and Germany's industrial production have both started to cave as well. Germany is the world's largest export economy and the eurozone economy is heavily reliant on exports as a whole. Danske notes that despite difficulties in the US, the US economy was able to bounce back pretty quickly from the Japanese earthquake and its subsequent impact on vital electronic parts exports. Europe, on the other hand, has been slow to respond, and this has meant a build up in inventories.
Excessive inventory levels are often a precursor to recession given discounting must follow in order to clear stock while new orders dry up. Europe is also facing austerity measures across the length and breadth of the continent and right across the Channel, so domestic demand is not a given at any price. Normally a government would respond to a recession with fiscal stimulus measures but the eurozone governments are being forced to go the other way and cut budgets. Unemployment is growing.
Recessions also usually force lower funding costs but in Europe's case funding costs are much higher in the peripheral states and credit has tightened as a result of the risk. General political risk adds to the uncertainty and all of the above is being reflected in a large drop in stock prices, which reduces wealth. If Gibraltar is the “rock” then the hard places are abundantly spread.
But it's not all doom and gloom, suggests Danske.
For starters, inventory levels naturally cycle. Excess inventory leads to a halt on orders and price discounting, and recession leads to more of the same. Then eventually the shelves are emptied and inventories need to be restocked. Such restocking supports economic growth. In other words, Danske expects the current inventory headwind to become a tailwind for Europe later in 2012.
We also note that former ECB president Jean-Claude Trichet twice stubbornly stuck to the ECB mandate of inflation control over the turmoil of the last four years with all the foresight of house brick – once by raising the eurozone cash rate in late 2007 when the Fed was madly cutting in the wake of the credit crunch, and again more recently as he took the rate from a GFC 1.0% up to 1.5% despite the eurozone threatening to implode every other week. His more sensible successor, Mario Draghi, cut the rate to 1.25% on the way back from his investiture and with the Fed rate effectively way into the negative given quantitative easing, Draghi still has plenty of room to move.
Most importantly however, Danske Bank believes slower growth in Europe will be offset by stronger growth in the US and China.
A few months ago Americans were a-feared of a double dip but since then the numbers have been looking better. In the first half of 2011, US GDP grew by an annualised rate of only 0.8%, notes Danske, when back then the eurozone posted 1.9%. The eurozone is slowing but the US rebounded to 2.5% for the September quarter (let's hope that number is not slashed on revision as the March quarter number was) and forecasts are for 2.8% in the December quarter.
Danske puts the improvement down to the fall in oil prices, which provides an effective lift to incomes, a reversal of earthquake impact on America's important auto industry, and a decline in the US savings ratio (a lot of which also reflects car purchases). Furthermore, US consumption growth is on the improve despite continuing low consumer confidence surveys. It's not the first time confidence surveys have been a poor indicator of consumption, Danske notes.
Danske suggests US fourth quarter growth might reach 3% but is forecasting an average 2.5% for 2012 given we still don't know exactly what fiscal tightening is yet to come. Aside from the fiscal wrangling, Danske suggest the US economy will be supported by ongoing growth in emerging market demand for US exports, reasonable corporate earnings growth underpinned by very low financing costs, moderate jobs growth and lower inflation.
Speaking of lower inflation, that takes us across now to China.
The Chinese economy slowed over the first three quarters, Danske notes, to below 8% growth – the weakest pace since the GFC hit (measuring growth over the specific period, not year on year for each quarter as Beijing does to arrive at plus 9% numbers). A big jump in food prices saw inflation surge to above 6%, and food represents about one third of China's domestic consumption. But food inflation has now eased, and September's year on year CPI was back to 5.5%.
Danske expects that number to keep falling, and reach 3% by the middle of 2012 (Beijing's target is 4%). What was a headwind in 2011 will become a tailwind in 2012, providing a boost for income growth and no further reason for monetary tightening. There is even a chance of some easing ahead via the bank reserve ratio, Danske suggests.
And it won't just be China but all emerging markets that will benefit from falling inflation. In India, for example, food represents a full 60% of consumption. The emerging market slump of early 2011, based on the food price factor, will turn into growth again in 2012, Danske suggests.
A rebound in the Chinese economy in particular will act as a stabilising force for global markets, just as Europe offers a destabilising force.
Markets have spent all 2011 worried about the confluence of all three negative factors – European crisis, US double dip, Chinese slowing. As far as Danske is concerned, the European crisis will remain with us but won't ultimately kill us while the US and China will spend 2012 providing a global economic offset.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.
