Global update: Are we approaching a turning point?
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It would seem that the absence of Eurozone politicians over the holiday season has given the markets renewed confidence, however economic indicators suggest the world economy is still slowing down.
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Clearly the world economy is in another soft patch having enjoyed a modest rebound from 2011 - this bumpy pattern of activity is what we would expect from a world economy that is deleveraging and does not have the strength to generate a self-sustaining recovery.
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Although macro numbers remain poor, they do not seem to be getting any worse. The OECD's leading indicator tracks activity reasonably closely and suggests that although growth is still weakening, we may be getting closer to a turning point.
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Overall we see the US continuing to grow, albeit slowly, whilst the Euro area and UK remain in recession. We have not downgraded our world growth forecast this quarter and, having been at the pessimistic end of the spectrum, we are now in line with consensus on 2012 GDP.
Eurozone risks:
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Macroeconomic data has gone from bad to worse. Second quarter GDP figures showed the Eurozone to have contracted 02%, making it the third consecutive quarter without growth - even Germany's recent stellar performance now appears to be fading and it seems almost certain that the Eurozone will be in technical recession by the end of the year.
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Investors are looking at a number of events in September that could present both upside and downside risks. Germany's constitutional court is set to give an initial ruling on the legality of the European Stability Mechanism - we expect this to be a formality which, when passed will enable the fund to use the ECB to buy government bonds on the secondary market.
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In addition, Spain is expected to finalise the estimated cost of bailing out its banking system, which is likely to confirm that the country will require less than the €100bn on offer.
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Once the market realises that bail-out funds are not large enough to help Italy in a meaningful way, we expect to see Italian government bonds (and equities) underperform their Spanish counterparts.
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Lastly for September, the Troika are set to complete their first review of the Greece package - for now, we expect them to show flexibility over any fiscal slippage in recent months, however we continue to forecast a Greek exit by the middle of next year in our baseline forecast.
Emerging Markets: Activity slowing but scope for further stimulus
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As advanced economies have slowed, emerging nations are experiencing the repercussions as weaker international trade, capital repatriation and lower commodity demand and prices have stymied economic activity.
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We have marginally reduced our 2012 GDP forecast for China (7.8% down from 7.9%), however we continue to believe that a turning point will occur in the third quarter despite weakness of the July data, with an improved final quarter of the year providing momentum in 2013.
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Elsewhere in the emerging world, we have significantly downgraded our 2012 growth forecast for Brazil due to tepid second quarter data, however signs of a pickup have occurred and we expect this momentum to generate stronger growth in the second half of the year.
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Overall we have reduced our growth forecast for the emerging world this year due to softer data, though we expect a pick-up in activity in the second half of this year and into 2013. Moreover many countries retain significant scope for further easing if the outlook deteriorates further, especially in China. For this reason, we continue to see a hard landing as a low probability event.
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