World Risk Developments February 2015

world-risk-developments-february.jpg

What happened while you were on holidays?

Welcome to our first newsletter for 2015. In our February bulletin we always look back at what happened over the holiday break. This time, as always, has seen a mix of good and bad news.

View a summary of this month's edition.

Good news

The IMF added its voice to a chorus foreseeing a pick-up in the world economy. Its World Economic Outlook Update released last month predicts a modest strengthening of global growth in 2015 — facilitated by cheap oil, monetary stimulus, and a resurgent US economy.

Oil prices continued to fall over December and January, delivering savings to fuel consumers around the world. Oil prices are now 55% lower than their peak in June. The IMF estimates that the price plunge will add 0.3-0.7% to global GDP growth this year — by promoting private spending in oil importing countries (such as the US, Europe, Japan and China). Indeed global consumer spending has accelerated sharply — retail sales are now growing at their fastest pace in three years.

Oil is likely to remain cheap for some time. This is because the price slump has largely been caused by supply factors likely to reverse only gradually and partially. The International Energy Agency expects oil demand growth to accelerate in 2015 (albeit by a modest 0.9 mb/d). But OPEC’s decision to maintain output in the face of increased non-OPEC production coupled with still-rising North American production, has led to the largest oil glut since the mid‑1980s. While the US oil rig count has fallen 15% since its October peak and oil investment projects by high cost operators are being scaled back or put on hold, supply growth is not expected to moderate before late 2015. Sustained lower oil prices will subdue growth in Australia’s export earnings from LNG, but also provide benefits to energy-consuming export industries

Central banks have been responding to growth concerns and disinflationary pressures by lowering official interest rates and creating liquidity.

Among those to do so have been the ECB, which finally satisfied markets with a bolder-than-expected quantitative easing program in January. This includes combined asset purchases of €60b a month until September 2016 (or until inflation reaches the ECB’s target of close to 2%). The Bank of Canada also surprised markets by cutting interest rates by 25bps to 0.75%. As well as cutting next fiscal year's inflation forecast, the Bank of Japan expanded two lending schemes aimed at lifting credit growth.

Many emerging markets also cut interest rates — January saw unexpectedly early cuts in India (25 bps), Peru (25 bps), Egypt (50 bps) and Turkey (50 bps). Several other markets are expected to follow suit to combat sluggish growth and subdued inflation — including China, Thailand and South Korea.

Meanwhile, amid signs that UK inflation reached its lowest level since 2000 in December, the Bank of England held rates constant despite strengthening growth momentum. Similarly the US Federal Reserve lowered its projected trajectory of policy rates — although this path remains well above market expectations.

Estimates came out in late-December suggesting a resurgent US economy will fuel global growth. The US grew at an annual rate of 5% in the third quarter of 2014 — its fastest pace in over a decade. In fact, the US was the only major economy for which the IMF upgraded growth projections in January. GDP growth is projected to exceed 3% in 2015–16, largely due to more robust private domestic demand. The upswing in real earnings and consumer sentiment is being propelled by lower oil prices, low mortgage rates and an improved labour market (the unemployment rate has reached a 6½-year low of 5.6%). These tailwinds will offset the effects of a gradual rise in interest rates and USD appreciation, which will thwart net exports.

Bad news

On the negative side of the ledger, China grew at its slowest pace in 24 years, the IMF downgraded its outlook across most of the globe, and Russia slipped further into the quagmire.

Statistics released in mid-January showed that China grew 7.4% in 2014, the slowest pace since 1990. Policymakers are rebalancing the economy away from investment-led growth toward consumption and services. However, consumer spending has failed to offset softer public and real estate investment, causing the economy to slow faster than anticipated. Beijing has responded by bringing forward spending on infrastructure projects and cutting interest rates in late November. Nonetheless China’s economic rebalancing is expected to weigh on the growth of demand for Australia’s mineral exports. Although the RBA expects rising demand by Chinese households for rural products and services could provide some offset.

While the world is still expected to achieve faster growth this year than last, the forecast improvement has abated. The IMF downgraded its outlook on most economies, except notably the US. The positive impact from lower oil prices has been stunted by a soft investment outlook in Europe and most emerging economies, prompting the largest downward revision in three years.

The re-election of Shinzo Abe in December and a plethora of monetary stimulus will not be enough to lift annual Japanese growth above 1% over the next two years as lacklustre wage growth and deflation crimp household spending.

Russia’s outlook has deteriorated over the last two months as double-digit interest rates, tumbling oil prices, western sanctions and a weaker rouble threaten to cripple the banking sector and hinder the country’s ability to service its offshore debts. Russia’s occupation of Crimea plus support of separatists in Donbass has brought about further sanctions and it appears relations with the West will remain frosty. Ratings agencies have downgraded Russia’s sovereign debt with Standard and Poor’s recently cutting Russia’s debt to junk status.

The ECB launched its version of quantitative easing (see above) to combat deflation and spur demand. But the euro area will most likely remain stuck in secular stagnation as inadequate investment spending, particularly in core economies, and weak export demand weigh on growth. Adding further risk to the European outlook are the growing odds of a Greek exit. The heavily left‑leaning Syriza party has won the recent Greek elections after promising to undo mandated austerity measures and restructure Greek debt held mainly by fellow EU countries. This will not sit well with EU leaders, who could force Greece out of the euro area.  

Volatility in financial markets has risen as ongoing uncertainty over oil prices and the path of US interest rates caused investors to pull out of riskier emerging markets. An estimated US$11.4b of capital fled emerging markets in December — the sharpest retrenchment since the 2013 ‘Taper Tantrum’. But the latest datum suggests portfolio flows into emerging markets recovered in January. Greater investor risk aversion has also weighed on the AUD — which is now down 6% against the USD since the end of December.

Conclusion

Post-holiday blues are afflicting the global economy. Lower oil prices, easier monetary policies and an accelerating US economy will stimulate global growth. But developments over the past several months suggest downside risks to the outlook prevail. In particular, slowing Chinese growth, increased financial market volatility, and growing geopolitical tensions in Russia continue to trouble the outlook.

Cassandra Winzenried, Senior Economist
cwinzenried@exportfinance.gov.au

Fred Gibson, Economist
fgibson@exportfinance.gov.au

The views expressed in World Risk Developments are Export Finance Australia’s. They do not represent the views of the Australian Government. The information in this report is published for general information only and does not comprise advice or a recommendation of any kind.  While Export Finance Australia endeavours to ensure this information is accurate and current at the time of publication, Export Finance Australia makes no representation or warranty as to its reliability, accuracy or completeness.  To the maximum extent permitted by law, Export Finance Australia will not be liable to you or any other person for any loss or damage suffered or incurred by any person arising from any act, or failure to act, on the basis of any information or opinions contained in this report.  

Photo credit: © Yorgos Karahalis / Reuters / Picture Media