The year just ending was challenging for the world economy – the US economy sufered a signifcant slowdown, Japan was hit by a devastating earthquake and Europe’s sovereign debt crisis deepened. Despite these shocks, a strong growth performance in emerging markets enabled the global economy to expand by 3.5% in 2011, a pace we expect to continue in 2012, as a rebound in China’s growth and a continued recovery in the US economy ofset a likely recession in Europe.In our view 2012 will see the turning point in the European sovereign crisis. Recent events have seen dramatic political shifts in the peripheral euro zone nations, especially Greece and Italy, which should boost reform and, ultimately, ensure that the region emerges stronger and more stable. The situation in Greece is stabilising, and thechanges now being made should removthe country from the spotlight.Italy is where the key risks and challengelie, in our opinion. We believe the countris solvent: Italy has signifcant economicpotential, low private sector debt, the highest household wealth among the G7 and a record of delivering primary surpluses during the past decade. The key challenge going forward will likely bethe ability of politicians to push though growth-enhancing reforms in order to unlock Italy’s potential. We note recent changes in the government point in the right direction. We are particularly encouraged by progress thus far in Spain, which has demonstrated a strong commitment to adjustment, as well as by Ireland’s advances in competitiveness which havturned around market sentiment. Irelandhas doubled its trade surplus since 2008and robust export performance has morthan made up for the weakness in the domestic economy. We expect France to remain in the spotlight in 2012, as elections approachand doubts are raised about its ability to hold on to its AAA status. In our view, despite the government’s recent announcement of additional spending cuts, we believe more fscal measures will be required to avoid a downgrade, as growth will likely be weak in 2012.
Indeed, we believe the eurozone economy is sliding into recession which at best will be mild and last only for a couple of quarters, although there are considerable downside risks. While the fscal austerity measures and reforms being put in place are necessary for the peripheral economies to regain market confdence and restore competitiveness, they will likely have a negative impact ongrowth. Growth will also sufer from the acceleration in bank deleveraging that Basel 3 regulations will require in 2012. We expect eurozone growth to decline to 0.4% in 2012 from 1.5% in 2011. Eventhe data out of Germany has turned down recently. We expect the European Central Bank (ECB) to continue reversing the interest rate hikes of 2011 and see another 25bp cut early in the New Year. We also expect the ECB to continue buying peripheral country bonds, albeit at a measured pace, and to keep its various liquidity taps open.
Fortunately, the United States appears to be recovering, albeit slowly, after a surprisingly weak frst half of 2011. There has been a clear improvement in the economic data in the past couple of months, with consumers showing surprising resilience and frms maintaining a decent level of investment. We expect the economy to strengthen further in 2012, as some of the headwinds from Europe abate, credit growth picks up and the housing market stabilises. The Fed has also signalled that it will leave its ofcial interest rates close to zero through to mid 2013 at least, providing further support to the economy. We have revised up our forecast for US growth to 1.8% for 2011 and 2.3% in 2012. Key risks we see facing the US economy are that Congress fails to agree to stem some of the near-term fscal drag (2% of GDP in 2012) and, more importantly, that it fails to agree on longer-term defcit reduction measures in the longer term to avoid a more serious downgrade by ratings agencies. We remain confdent that some agreement will be reached.
There has been much conjecture recently about the other motor of the world economy – China. Although we believe the risks from the property, banking and small business sectors are overstated, we do see growth slowing to an annualised 7% around the turn of the year. We expect that the economy will avoid a hard landing, however, and that growth will accelerate to almost 9% by H2 2012. Infation is now falling sharply but we do not expect a major policy stimulus to follow as a result. The government is likely to launch targeted measures in some parts of the economy instead.
For the rest of emerging Asia we see a slowdown in growth but, again, no hard landing, as real interest rates are low and domestic demand is still robust. The landing could be a little harder in a few economies as rapid property price increases and high credit growth potentially reverse in 2012. But while authorities have already shifted policy away from combating infation, as with China, we don’t expect major policy relaxation unless the growth or infation outcomes are signifcantly lower than we forecast.
Japan, nine months after its devastating earthquake and tsunami – which damaged global supply chains – is likely to have seen its economy contract by around 0.5% in 2011, not helped by a strong yen. We see growth of just over 1% in 2012, helped by further post-quake reconstruction spending by the government. But the strength of the yen and the crisis in Europe could turn out to be a bigger drag on the economy if policymakers do not implement the right measures.
Overall, we expect growth in 2012 to hold up reasonably well. If the threat of a systemic event in Europe fades in the early part of next year, as we expect, 2012 could ofer signifcant upside potential for risk assets.
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Deutsche Bank