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Market views

 Global Investment Strategy - April 2012

Current Investment Policy Negative Neutral Positive
Bonds Alternatives  Cash, Equities, Property
UK Equity, North American Equity Asia (ex Japan) Equity Europe (ex UK) Equity, Emerging Markets Equity, Japan Equity
UK Govt Bonds, Overseas Govt Bonds (developed) UK Index-Linked Bonds, UK Investment-Grade Corporate Bonds, Overseas Govt Bonds (emerging), Global High Yield Corporate Bonds
Global Property UK Property, Continental European Property

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

Economic growth
Our detailed quarterly review has resulted in some changes to our global growth forecasts. Our higher oil price assumption (discussed below) implies an additional headwind to growth. However there are some offsets. Firstly, confidence in Europe is holding up rather better than seemed likely three months ago, helped by the success of the ECB’s long term financing operations. Secondly, oil prices do not tell the whole energy story, particularly in the US where spot prices for natural gas have halved over the last year to their lowest level in more than a decade.

Consequently, our projections for aggregate growth have been revised down only slightly. The bigger picture is that we still see 2012 as a year of sub-trend growth in the advanced countries, but with some quarterto-quarter acceleration during the year, which should set the scene for broadly trend growth in 2013. We continue to expect that the emerging and developing economies will record lower growth this year than last year but will accelerate moderately next year. Putting these together, we expect that overall global growth will slow from last year’s 3.7% to 3.3% in 2012 (shaded down from our earlier 3.4%) before picking up to a broadly trend 3.9% pace in 2013 (unchanged forecast).

Within these overall numbers, we have slightly cut our forecasts for the US but remain a little above consensus at 2.5% this year and 2.9% next year. In the UK, we have reduced our growth forecast for 2012 to 0.5% but have slightly increased our forecast for 2013 to 1.9%. We continue to expect a contraction in the eurozone this year, but of 0.5% rather than 0.7%, followed by a return to growth of 1.0% in 2013. Japan is still expected to expand at a rate clearly above its long-term trend, with gains of 2.0% this year and 1.4% in 2013. That, of course, reflects a bounce back thanks to reconstruction work following last year’s earthquake and tsunami.

Inflation
We assume that the elevated risk premium in oil prices will persist for some time and that the Brent price will move up from $111 on average last year to $122 this year (previous forecast $105) before easing back to $119 in 2013 (previously $107). Higher oil prices mainly affect headline rather than ‘core’ measures of inflation but even the latter can be pushed up for a time by factors such as transportation costs.

As a result, we have raised our forecast of headline inflation in the main developed economies by 0.4 percentage points this year and by 0.1 percentage points next year. However, it is worth pointing out that the $11 average increase in the oil price that we expect this year is still substantially less than the $30 increase seen last year. Meanwhile, global food price inflation appears to be easing and spare capacity continues to act as a restraint on underlying inflation in the developed world (although this effect may diminish when growth accelerates).

The result is that we still expect a significant deceleration of inflation from last year’s pace, but with less of the effect coming through this year. Our latest forecast is for inflation in the main developed countries to slow from the 2.5% seen last year to 2.1% this year and 1.7% in 2013.

Interest rates
Our detailed quarterly review has also had some impact on our interest-rate forecasts, with the timing of the first upward move in rates pushed out a little further into the future. In general, central banks are still heavily focused on the downside risks to economic growth rather than on the upside risks to inflation. As a result, higher oil prices are being seen as a tax on consumers that may depress activity rather than a development which could push up mediumterm inflation expectations.

Moreover, in January we had revised guidance from the US Federal Reserve. Their view is that the economic outlook is now “likely to warrant exceptionally low levels for the federal funds rate at least through late 2014” rather than “at least through mid-2013”. In our view, this commitment lacks credibility: it is conditional on events particularly in the labour market. Fed chairman Bernanke has conceded that ‘exceptionally low’ does not rule out an increase from near zero. Nonetheless, it does make a US rate rise next year even less likely. That, in turn, will tend to discourage tightening elsewhere round the world.Indeed in the near term we may well see further rate cuts in some countries where this is possible or, in countries where interest rates are already effectively at zero, further unconventional measures.

Our central forecast is for a first US rate hike to take place in the third quarter of 2013 rather than the second quarter. We now see the Fed Funds rate at 0.75% by the end of 2013 rather than 1.00%. That is still well ahead of the Fed’s guidance but our view is that the labour market will tighten more rapidly than Mr Bernanke currently expects. While a further round of QE cannot be ruled out, the tone of the latest FOMC minutes suggests that it is becoming less likely.

In Europe, the ECB’s policy appears likely to remain firmly on hold in the near term. Above-target inflation makes the rate cut that seemed possible a few months ago seem far less likely. Equally, no early tightening of policy seems likely. Indeed, we have pushed back our expectations for the first hike in rates from late 2013 to the first quarter of 2014. In the UK, we now see the first rate hike taking place in the fourth – rather than the third – quarter of 2013. In the meantime, the jury remains out on whether the asset purchase target will be increased again in May when the current round of QE is completed.

Finally we no longer expect any interest-rate increase in Japan before the end of 2013. Government moves to curb the public deficit by increasing the sales tax will, if implemented, justify monetary policy staying accommodative for longer.



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