Hamish McRae: Good reason for optimism, but our growth will depend on the US economy
Economic Life: The ECB does seem to have started preparing the markets for higher interest rates and when it does that will add pressure on the Bank of England to follow suit
Friday 14 January 2011
A continuing and strengthening global recovery or a year when things slow down? There is now a clear divergence of views both about what is happening to the world economy right now and what is likely to happen in the months ahead. It is an unusually stark difference, so big that clearly one group is going to be right and the other lot wrong, and self-evidently it matters hugely to all of us which camp is going win out.
The more pessimistic band includes the World Bank, which thinks that global growth will be only 3.3 per cent against 3.9 per cent last year, with emerging markets up 6 per cent overall and the developed world up 2.4 per cent. It notes that the emerging world came out of the financial crisis "with flying colours" but is worried about the tensions between the slow-growing and heavily indebted developed world and the fast-growing developing countries.
The former will continue to have very low interest rates while the latter are tightening monetary policy. So there will be a great incentive for funds to flow from one to the other, thereby potentially destabilising currencies. There have long been concerns about the US dollar rate against the Chinese yuan, though actually if you allow for the differential inflation rates between China and the US, the yuan has gone up quite a lot. But concerns are more widespread – witness the fact that Brazil has become increasingly worried about the appreciation of the real versus the US dollar.
Other worries cited by the World Bank include rising energy, commodity and food prices, the weakness of banks in many developed countries, and the sovereign debts in parts of Europe.
The plight of the weaker eurozone countries certainly hangs over Europe, as does the probability that the European Central Bank will start to increase interest rates this summer. There was no move yesterday and of course none was expected – just as there was nothing new out of the Bank of England. But reading between the lines, the ECB does seem to have started preparing the markets for higher rates and when it does, that will add to pressure on the Bank of England to follow suit.
So there are lots of reasons for caution, as you would expect at this stage of the cycle. But there is also a growing band of optimists, people who think that growth overall this year will be higher than last and see things such as rising oil prices as evidence of faster-than-expected growth rather than a phenomenon that will depress growth. Among this group, the ones that prefer to see the bottle as half-full rather than half-empty, are Goldman Sachs and Evolution Securities.
The Goldman view, noted here before, is that growth worldwide will be 4.6 per cent this year, with the US growing by 2.7 per cent, the UK by 2.4 per cent and the eurozone by 2 per cent. Those forecasts are all higher than the consensus and when they first came out last month it seemed that Goldman was rather on its own. Now I have just been looking at some work by Ian Harwood at Evolution Securities, who is, if anything, more bullish than the Goldman team. US growth this year is projected at 3.5 per cent, with the UK at 2.5 per cent and the eurozone at 2 per cent.
You can see the thinking behind this bullish view in the charts. In the top one there is what is happening to global output, the red line, which has eased back a little, coupled with the expectations of manufacturers, the blue line, which has perked up a little. Insofar as what manufacturers see as likely future demand is a lead indicator for output, this bodes well. As a small sidelight on this, the latest surveys of UK manufacturers have been very positive.
The next graph down shows what has been happening in the US. The big surprise last year was how resilient consumers have been, despite the still dreadful housing market. Disposable income has fluctuated a lot but as you can see, the blue bars showing actual spending have been gradually getting bigger for the past 12 months.
The eurozone too, taken as a whole, has beaten expectations. There has been so much focus on the bits of the eurozone that have disappointed, with Portugal currently the whipping boy of the region, that we tend to forget how well Germany has done, and of course it remains the region's largest economy. France and even Italy also finished the year in better shape than most people had expected.
And us? Well, the plain fact is that growth last year was better than expected and that our manufacturers now are very optimistic. Manufacturing export sales and orders are the strongest since 1994, according to British Chambers of Commerce. Service industries are less so (you can see how the two lines diverge at the extreme right-hand end of the bottom graph) so it is important not to get carried away by this, but it does appear that the export sector will do very well this year.
So are the optimists or the pessimists more likely to be right? My own instinct would be to side with the optimists, who were after all right last year. As far as the UK is concerned, I don't buy the argument that the spending cuts will derail the recovery for two reasons. One is that the only closest experience we have to that was in the early 1980s, and they clearly did not do serious damage to the recovery then. The other is that the huge budget deficit did not do much to offset the UK recession, for we had the biggest fiscal deficit in the developed world and still had one of the deepest declines in output measured from peak to trough.
Of course we don't know the counter-factual: what would have happened had we ran a deficit similar to that of Germany or France. But if extra public spending did not help much when the economy was heading down, it is at least plausible that cuts in public spending will not do much damage when the economy is heading up.
True, there are worries here in the UK and at the head of the list must be our inflationary performance, which has become really serious. We are going to have to have higher interest rates soon, I expect before the summer is out. But remember the UK is only a small part of the world economy and what really matters is what happens to that rather than what happens to us.
Here there is surely one indicator that matters above all others: US consumption. Consumers account for 70 per cent of the US economy. If they can keep going and the US has something like 3 per cent growth, then the recovery really would be secure. There is still a lot of spare capacity across the developed world, though much less in the emerging economies. That spare capacity is ready to produce the goods and services. All we need is willingness to shop.
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