Market views

 Policy changes over the month, when applicable, are shown by arrows (<<, >>)

• There have been no changes to our economic growth forecasts since last month’s report. Focusing on developed nations (the average of the US, UK, continental Europe and Japan), we forecast a slowing of growth from 2.4% in 2007 to 1.3% this year (previously 1.7%), followed by a modest acceleration to 1.6% in 2009 (previously 2%).  For the world including developing nations, we see growth slowing from 4.8% in 2007 to 3.8% and 3.7% in 2008 and 2009 respectively. In other words, our forecasts paint a picture of a drawn-out period of subdued growth rather than a quick recovery. As a result of these changes, risks are more evenly balanced although still somewhat skewed to the downside. Our forecast for developed nations’ growth is broadly in line with the consensus over the next six months, but below consensus in the subsequent six-month period.
  
  
• Global inflation forecasts for 2008 and 2009 are unchanged compared to a month ago. Developed-world headline inflation is expected to average 2.8% this year (up from 2.2% previously) but should fall back to about 1.6% in 2009 assuming some weakness in commodity prices. Core inflation is forecast to rise to about 2.1% and 1.7%, respectively (previously we estimated 1.9% for both years). While our growth forecasts imply the opening up of a bigger negative output gap in the developed world, at a global level it is expected that the current positive output gap will do no more than narrow. Our inflation forecasts are generally in line with the consensus, with risks weighted to the upside.
  
  
• Our government bond yield forecasts continue to point to higher yields in 12 months’ time. US bonds appear the priciest on a one-year investment horizon and we expect the 10-year Treasury yield to rise to 4.5% from 3.6%. In the UK, eurozone and Japan we also forecast rising yields, although to a more limited extent. Although there is little long-term value in longer-dated government bond markets, yields are likely to remain volatile within a trading range in the short run.  Nevertheless, a sustained rise in yields is expected towards the end of 2008.
  
  
• SWIP’s bottom-up view of earnings continues to be revised down gradually and this has prompted a 2-3% reduction in both our 2008 and 2009 calendar year-end equity market price targets. The most recent aggregation of end January profit forecasts suggests a modest 7% increase during 2008, followed by 6% in 2009; a further downward adjustment is still possible over the next few months.
  
  
• As a result of the recent market rally and forecast adjustments, prospective equity market returns have fallen compared to where they were in our last report. Still, equities continue to offer the highest returns on a 12-month view. Bond returns have inched higher following the recent rise in yields and the UK commercial property return continues to rise, although it remains the least attractive asset class. Following some small changes to our currency forecasts, sterling is expected to weaken modestly against a basket of major currencies. We have taken advantage of the combination of equity market weakness and extreme investor positioning in March to buy more US equities. As a result, our cash allocation has moved back to neutral.