Market views

 Global Investment Strategy - May 2012

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

Economic growth
Our economic growth forecasts are unchanged. We expect global growth (using PPP weights) to slow from 3.7% last year to a fairly subdued 3.3% this year before picking up to 3.9% in 2013 – in line with past trend growth. In the developed economies, we expect growth to remain very subdued this year at only 1.5%. But in contrast to 2011, we forecast some quarter-to-quarter pick up as the year progresses which should see the developed economies growing by 2.2% in 2013.

Growth in emerging and developing countries slowed from 7.3% in 2010 to a still-robust 6.0% in 2011. We project some further slowing – to around 5.1% – this year. Our forecast is for growth to reaccelerate to a 5.5% pace in 2013. This would leave growth in the developing world marginally below the average pace of the last 15 years but well above earlier trend rates. In other words, we believe that the improved relative growth performance of developing world will continue, albeit subject to some cyclical slowing in the near term.

We continue to expect that growth in the US will accelerate from a subdued 1.7% last year to 2.5% this year and to 2.9% in 2013, driven by renewed strength of business investment, feeding through to stronger employment, incomes and consumer spending. The initial estimate of GDP growth in the first quarter (+0.55% or 2.2% annualized) was in line with our expectation, albeit the detail showed some surprising strength in consumer spending and an unexpectedly large contraction in government spending.

In contrast, the initial estimate of first quarter GDP growth in the UK showed a 0.2% quarterly fall. That followed a 0.3% drop in the final quarter of last year, thereby putting the country back in recession on one popular measure. However, initial GDP estimates are notoriously prone to revision and the picture given by survey evidence is less weak. For the moment we retain the view that the UK will show growth of 0.5% this year followed by 1.9% in 2013.

In the eurozone, we expect the combination of fiscal austerity and weak confidence to result in GDP shrinking by 0.5% this year followed by modest growth of 1.0% in 2013. Weak survey data appear consistent with our view that the eurozone suffered a second successive quarterly contraction in the first quarter of this year; we believe output will fall again in the second quarter.

In Japan, the economy appears to be regaining momentum. We continue to forecast that reconstruction work will see the economy bouncing back from last year’s earthquake-induced 0.7% contraction. We look for above-trend growth of 2% this year slowing to 1.4% in 2013. In China, we expect growth of about 8% both this year and next, down from just over 9% last year. An outright “hard landing” is unlikely although the changing mix of growth away from investment and towards consumer spending may have adverse implications for producers of hard commodities.

Inflation
Recent inflation developments have been mixed. On the one hand, oil prices have eased back from the peak levels seen in March, with Brent dropping from around $125 per barrel into the $110-$115 range. This is starting to feed through to lower petrol prices. But against this, underlying measures of inflation are proving stickier than central banks had expected. This suggests that there may be less spare capacity in the global economy than previously assumed.

Overall, our view remains that inflation will ease back rather than fall precipitately as energy price effects fade and as global growth runs at a moderate pace. On aggregate, we see CPI inflation in the US, eurozone, Japan and the UK easing back from 2.5% last year to 2.1% this year and to 1.7% in 2013. The last figure is marginally below the aggregate 1.8%- 1.9% level implied by the various national targets but not by enough to justify indefinite maintenance of ultra-accommodative monetary policies should economic activity pick up.

Interest rates
For the most part, central banks remain dovish in the face of some disappointing economic data and downside risks to the near-term outlook. Indeed, we have recently seen rate cuts of 0.5% in India and Australia and of 0.75% in Brazil. For its part, the Bank of Japan has responded to political pressure with a further increase in its asset purchase programme. Nonetheless we continue to see the start of a rate tightening cycle in some countries before the end of 2013.

In the US, the Federal Reserve has maintained its conditional commitment to keeping interest rates very low through to the end of 2014. That commitment, however, may be a bit misleading. Of the 17 FOMC participants who are either permanent or rotational voters, as many as 13 now expect a rate hike before the end of 2014. Of those, six expect a first move by the end of 2013. So we remain comfortable with our forecast that the first rate hike in the US will come in the third quarter of next year and that rates will reach 0.75% by the end of 2013. This is underpinned by our belief that US unemployment will fall more quickly than the Fed currently expects.

In the eurozone, we do not foresee any increase in interest rates taking place before the first quarter of 2014. Indeed a cut in rates cannot be completely ruled out in the near term. That said, another round of unconventional measures – such as a third three-year refinancing operation or renewed SMP bond purchases – seems more likely.

In the UK, some members of the MPC are becoming less dovish in the face of persistent above-trend inflation. We continue expect an upward move in interest rates from the final quarter of next year in response to strengthening economic activity.

Finally, the Bank of Japan appears fully committed to its target of eliminating deflation and achieving positive inflation of around 1%. Renewed economic growth and the modest easing of the yen seen since the start of the year should help. Nonetheless, underlying deflationary pressures remain significant. As a result, near-zero interest rates look set to be maintained over the next two years.

The information contained in these pages has been derived from internal sources that we consider to be reasonable and appropriate. It also includes our views and expectations, which cannot be taken as fact.

Investment markets and conditions can change rapidly and as such the views expressed should not be taken as statements of fact nor should any reliance be placed on these views when making investment decisions. Past performance is not a guide to future performance.