SEB: US holds the key to economic recovery

The obstacles to a global acceleration in Gross Domestic Product (GDP) will become fewer in the next couple of years. Fading fiscal headwinds will combine with continued strong monetary policy tailwinds. The United States is poised for a sustainable growth surge in 2014-2015 and will achieve annual growth of around 3.5%.

This will also give the Eurozone greater opportunities to re-generate economic, financial and political stability, despite divergent and sluggish GDP growth of 0.8% in 2014 and 1.7% in 2015, following negative growth of 0.5% this year.

Global risk appetite will strengthen. This will lead to positive stock market performance, while industrial companies with strong balance sheets will be able to increase their capital spending and hiring during 2014 and 2015. Overall, GDP growth in the 34 countries of the Organisation for Economic Cooperation and Development (OECD) will accelerate from 1.2% this year to 2.4% in 2014 and 2.8% in 2015. Yet major cyclical differences in growth between countries and regions will persist, posing challenges to international economic policy cooperation.

Our relatively positive global scenario is based on two important assumptions: that inflation will remain low and stable, and that the low interest rate policies of central banks will be underpinned by macroprudential policies. There is a large quantity of idle economic resources in the US, Europe and Asia, which exerts downward pressure on wages and salaries as well as on commodity and energy prices, allowing central banks manoeuvring room to postpone key interest rate hikes and focus on sustaining growth and employment. This will also facilitate the implementation of vital restructuring policy measures and fiscal consolidation, although it is uncertain to what extent political leaders will take advantage of this opportunity.

Global monetary policy is approaching a crossroads. Frequent emergency interventions will be replaced by the main task of ensuring a normalization of inflation rates and preventing the re-emergence of financial imbalances. The communicative talents of central banks will be put to the test when it comes to persuading financial markets that they are in control of the situation and can ensure a continued low inflation environment. This also requires that over the next couple of years, political leaders and central banks can reach agreement on the way forward for macroprudential policies.

The US Federal Reserve will not raise its key interest rate until the second half of 2015, after more than six years of a zero interest rate. The federal funds rate will stand at 1.0% at the end of 2015. Due to an improved economic and financial outlook, the Fed will decide as early as this September to begin ´tapering´ its quantitative easing (QE) program. Such a decision will reduce the prevailing financial uncertainty and can easily be re-assessed if long-term yields continue to rise sharply. The Bank of England will keep its key interest rate at 0.50% until late in 2015, when it will carry out its first rate hike.

The European Central Bank (ECB) will help sustain the Eurozone economy with a further key interest rate cut to 0.25% in December 2013 and then stay put at this level in 2014 and 2015. The ECB will also offer new Long Term Refinancing Operation (LTRO) loans for the purpose of improving the functioning of the banking system in southern Europe and keeping interest rates low. The Bank of Japan will continue with its aggressive bond purchases and zero interest rate. Because of differences in monetary policies and economic conditions, the EUR/USD exchange rate will decline from 1.33 at the end of 2013 to 1.27 at the end of 2014 and 1.20 at the end of 2015.

The main upside risks in our forecast is that the faster growth rate in the US will have larger positive contagious effects on other countries than in our main forecast. On the other hand, there are big remaining challenges that carry downside risks. The risk of new reversals in growth is mainly connected to the continued financial and political weaknesses of the Eurozone and to the potential of emerging market countries, and their willingness, to reform their economies.

While stronger US growth is positive for the world economy, changes in US monetary policy - less stimulus and eventual tightening - may cause economic and financial problems for countries and regions that are in divergent cyclical phases from the US and have not yet achieved sufficient strength to cope with higher interest rates and yields. This is true, for example, of the Eurozone, which will still need a number of years before achieving its private sector debt deleveraging targets. Excluding the financial services sector, global debt today is higher than in 2007. This means that higher interest rates will have a major impact on consumption, capital spending, lending and government finances. Read more...

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