John Greenwood, chief economist, Invesco

Eurozone downdraft continues to hamper global growth, and is expected to keep investors in a search-for-yield mode

Developed and developing economies remain caught in the eurozone downdraft as a long series of crisis summits has brought the resolution of the debt crisis no closer. In his Quarterly Economic Outlook for Q3 2012, Invesco Ltd’s Chief Economist John Greenwood analyses the fundamental flaws in the architecture of the single currency as well as the future prospects of the eurozone and the global economy…

Further global economic weakness is unavoidable until a credible, sustainable resolution to the eurozone crisis is within sight. With the EU representing about one fifth of global GDP, this crisis is not only generating a recession in the region, but is severely hampering global trade, undermining growth in the UK, eastern Europe, North America as well as export-dependent Asia.
 
In view of the global economic weakness, central bank policy rates in the developed world are likely to remain close to the ‘zero bound’ for an extended period, with policy-makers periodically resorting to central bank balance sheet expansion via asset purchases. In this situation, I expects investors to remain in a search-for-yield mode, causing quality assets that generate safe and sustainable yields to be bid to a premium relative to assets generating lower income streams. As a result, I do not expect central banks’ quantitative easing efforts to produce the kind of upsurge in asset prices traditionally seen after a liquidity boost. In addition, I expect inflation to fall more than expected in the second half of the year and commodity prices to weaken further during the rest of the year.
 
As euro-area leaders are as reluctant as ever to embark on a far-reaching fiscal union that would correct the fundamental flaw in the architecture of the eurozone, I believe that the best hope for the eurozone as a whole is that the ECB provides additional 3-year LTROs. These could fuel a strong recovery in Germany and other core economies and have favourable spill-over effects on the struggling peripheral economies. In practice, however, the recessions in seven euro-zone countries – mainly in the periphery – are starting to drag down the economies of the core. As a result, I project real GDP growth of -0.3% across the eurozone this year and 2.8% CPI inflation.
 
Meanwhile, real GDP growth in the US appears to be losing momentum and the current policy impasse has shifted attention to the possibility of an adverse fiscal shock in early 2013 – i.e. the risk of a sharp cutback in government spending and a simultaneous rise in taxes together creating a hit to GDP of between -3% and -5%. I expect the US economy to continue to grow at a moderate rate, well below its potential, as households and financial institutions continue to repair their balance sheets. I project average real GDP growth of 2.3% for 2012, well below the 3-4% typical of the early stages of a recovery, and headline CPI inflation of 2.2% for the year as a whole.
 
The UK is following in the track of the US in terms of balance sheet repair, but starts from a worse position due to the greater leverage of its banks and households going into the downturn, and the larger size of its government sector, but also due to its proximity to and export-dependence upon the eurozone. I project a decline in inflation to 2.8% for the year as a whole, but the effects of high inflation in the first half of the year and the eurozone crisis will cap full-year real GDP growth at a very weak 0.4%.
 
The eurozone crisis also continues to dampen the prospects of major exporting economies of the emerging world such as China, the other East Asian tigers and Brazil. In China, neither the self-imposed domestic slowdown following the panic measures of credit expansion in 2008-09 nor the involuntary downturn in exports to its major markets appears likely to be turned around quickly. I project 8.0% real GDP growth for China in 2012, with CPI inflation at 3.5%. Slower growth in China combined with sub-par growth in the developed economies and a significant slowing in India is also expected to translate into weaker real GDP growth in non-Japan Asia, at 6.4% in 2012. Meanwhile, I do not expect Japan to be able to maintain the growth pace recorded amid the recovery from the disastrous tsunami of March 2011 and I also see Japan’s price indices gradually reverting to deflation again. Due largely to favourable base effects, I project 2.7% real GDP growth for the year as a whole and 0.6% headline inflation.
 

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