OECD slashes growth outlook for developed economies

The OECD yesterday urged developed nations to be prepared to do more to support the global economy. Revealing a sharply downgraded international growth outlook for the second half of 2011, the Paris-based economic organisation said that countries that have "credible fiscal frameworks" should enact "short-term fiscal stimulus" if there is a prolonged slowdown in economic activity.

The OECD also called on central banks to keep interest rates on hold and to use other unorthodox monetary policies, such as quantitative easing, to support growth.

The organisation's latest assessment of the global economic outlook said that growth in the G7 economies (with the exception of Japan) is likely to be less than 1 per cent, on an annualised basis, in the second half of this year. This is less than half the level of expansion it forecast four months ago.

The OECD expects Japan's next growth figures to be pumped by post-tsunami reconstruction spending. But the outlook for the rest of the world's developed industrial nations is very bleak. The German economy is projected to expand by 2.6 per cent in the third quarter of this year, before contracting by 1.4 per cent in the final quarter. Italy is expected to shrink slightly in the third quarter, before stagnating for the rest of the year. The OECD expects growth in the US, France and the UK to be almost wiped out by the fourth quarter.

"Growth is turning out to be much slower than we thought three months ago, and the risk of hitting patches of negative growth going forward has gone up," the OECD's chief economist, Pier Carlo Padoan, said. The organisation also warned that previously strong growth in emerging countries is showing signs of waning.

These latest forecasts are a considerable downgrade on the OECD's previous report in May, which projected average growth in the second half of 2011 of 2 per cent. The OECD blamed a still elevated global oil price, the debate about the US deficit, continuing uncertainty over the eurozone sovereign debt crisis and a general draining of business confidence for the sudden slowdown.

As well as urging developed economies to be prepared to alter fiscal and monetary policies, the OECD calls on European governments to speed up their response to the eurozone debt crisis and to recapitalise the continent's shaky banks. This echoes the recent recommendations of the new managing director of the International Monetary Fund, Christine Lagarde. At the central bankers' symposium in Jackson Hole, Wyoming, last month Ms Lagarde warned of a "debilitating liquidity crisis" if the lack of capital in the banking sector is not addressed.

The OECD had previously been a strong advocate of rapid cuts to public spending in order to restore economic confidence in the solvency of governments. But in this latest report the organisation admits that "stronger fiscal consolidation may have been exerting more drag on activity than anticipated". However, Mr Padoan, in an interview with Sky News, denied that he was suggesting that the UK Government should change course in its deficit reduction strategy.

Interest rates on hold

As widely expected, both the Bank of England and the European Central Bank (ECB) kept their policy interest rates on hold yesterday in view of the rapidly deteriorating domestic and international economic outlook. UK rates remain fixed at a historic low of 0.5 per cent.

The Bank of England's Monetary Policy Committee did not, however, decide to increase the £200bn programme of quantitative easing in order to boost the economy. Likewise, the ECB governing council decided to keep rates across the eurozone on hold at 1.5 per cent.

This year's monetary tightening by the ECB, which raised rates as recently as July, now appears to be over. Explaining the ECB's decision, the Bank's president, Jean-Claude-Trichet, said that he sees "intensified downside risks" to the European economy.

Richard Cochinos, of Bank of America-Merrill Lynch, said: "Trichet's not committing to cuts but at the same point in time he definitely wants to pare back expectations of any upside bias."