"We have trimmed our global growth projections for 2014 and 2015 to 2.6% and 2.8% respectively and also see lower growth in the emerging world in 2015. We continue to believe that the Federal Reserve (Fed) will end its quantitative easing (QE) programme by October and raise interest rates from June 2015. We see lower trend growth in the US as a result of a slowdown in productivity growth and less favourable demographics. The Bank of England (BoE) is likely to join the Fed in tightening, but the European Central Bank (ECB) and Bank of Japan (BoJ) are expected to increase stimulus. Our scenario risks remain tilted to the downside, with eurozone deflation and deterioration in the Russia-Ukraine crisis the greatest ‘known unknowns’.
The lower figure for global growth in 2015 reflects a slowdown in both advanced and emerging economies. In the former, this is due to the ongoing headwind from debt deleveraging in both the consumer and public sectors, and weak productivity growth on the supply side. In the latter, several emerging economies face inflation and rebalancing pressures that will likely weigh on growth.
Inflation
Our inflation projections are little changed, with a mix of upgrades and downgrades. The overall global figure for 2014 is marginally higher at 3.1% as a result of the increase in consumption tax in Japan, but elsewhere we have brought our forecasts down, particularly in the UK and eurozone because of softer agricultural and natural gas prices. In 2015 the slight increase in global inflation to 3.2% is driven by the US where we expect rent and wage costs to pick up. Slightly higher inflation in the emerging world also boosts the global aggregate.
Policy: divergence ahead
For the US we see the Fed as on target to end QE by October and raise interest rates from June 2015. This is expected to occur despite our sub-consensus growth view as we see unemployment continuing to fall and wages picking up, thus increasing inflationary pressure. In the eurozone, we expect the ECB to monitor the impact of recently announced measures to reduce bank funding costs before taking further action. In Japan, we have pushed out an acceleration in QQE (qualitative and quantitative easing) until October when the BoJ is expected to downgrade growth expectations. For the UK, we expect the first rate hike in February 2015 as a result of stronger activity. China is expected to leave the reserve requirement ratio (RRR) unchanged, but pursue other means of stimulating activity in selected sectors.
Scenario analysis: deflationary bias remains
We maintain our main scenarios, but have removed the ‘Trade war’ scenario as the island dispute between Japan and China has moved out of the spotlight for the time being. In its place we have created a ‘Productivity recovers’ scenario which represents a rebound in productivity, resulting in stronger growth and lower inflation than in the baseline.
Geopolitical risk remains very much centre stage given events in Russia and the Ukraine, and we have increased the probability attached to our ‘Russian rumble’ scenario to 6%. The cost of energy is expected to soar in such a scenario and lead to a stagflationary shock to the world economy, with the eurozone being most vulnerable.
We have also raised the probability on the ‘Eurozone deflation’ scenario given that growth appears to be faltering while inflation prints remain low. Offsetting these increases have been reductions in the probabilities attached to the ‘G7 boom’, ‘Capacity limits bite’ and ‘China hard landing’ scenarios. Overall the balance of probabilities has turned negative on growth and remains firmly negative on inflation, an indication that the tail risks lie in a deflationary direction. In this respect the risk to interest rates is to the downside with central banks likely to maintain stimulus in the face of a deflationary outcome."
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