Neil blake final_presentation

Dangerous Times: The Global Economic Outlook

[email protected]

Dr Neil Blake

Director of Economic Analysis

13th October 2011

Overview

• Recent Economic Developments: why is the economic recovery running out of steam?

• The economic outlook:– Can the Eurozone muddle through?– Will fiscal constraints strangle the US recovery?– Where does the UK fit in?– Can the emergers drive global economic growth?– Is the inflationary threat over?

• Implications for investors

Stock Markets are on the slide …

75

80

85

90

95

100

105

110

115

Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep

Stock Price Indices2010Q4 = 100

Source : Oxford Economics/Haver Analytics

USA

France

China

…and business confidence is collapsing

25

30

35

40

45

50

55

60

65

2005 2006 2007 2008 2009 2010 2011

Manufacturing Purchasing Managers' IndexIndex

Source : PMI/Markit

Eurozone

US manufacturing ISM

China

What has gone wrong?

• Partly a normal inventory cycle• High commodity prices damaging consumer

spending power• Coordinated fiscal retrenchment + monetary

tightening in emerging markets• Ongoing problems of the Eurozone – danger of

a second banking crisis• Continued weakness of bank lending and/or

credit demand• Worries over a double dip in the US

Currency areas are creating tensions• Some euro area countries have

current account deficits with offsetting capital flows financed by ECB, IMF and surplus governments.

• The deficit countries have weak growth but monetary policy is tightening and confidence is fragile

• All member countries want to maintain the euro but still not clear that they will take the necessary measures to do so

• The US has a large current account deficit with China financing it by buying treasuries

• The US has weak growth but monetary policy is set to remain expansionary and fiscal policy has tightened but..

• China etc has inflationary problems but is resisting any exchange rate changes

EUROZONE BUDGET BALANCES

(in per cent of GDP)

2009 2011 2013

0

-2

-4

-6

-8

2009 2011 2013* Germany, Netherlands, Belgium, Austria and Finland.** Italy, Spain, Greece and Portugal.

"North"*

"South"**

EUROZONE CURRENT ACCOUNT BALANCES

(in per cent of GDP)

2009 2011 2013

0

2

4

6

-2

-4

-6

2009 2011 2013

"North"*

"South"**

* Germany, Netherlands, Belgium, Austria and Finland.** Italy, Spain, Greece and Portugal.

Worries about Debt

30

40

50

60

70

80

90

100

110

1991 1995 1999 2003 2007 2011 2015

0

50

100

150

200

250

World: Government debtGeneral government gross debt, % of GDP


Japan (RHS )

US (LHS )

Eurozone (LHS )

Forecast

An age of fiscal retrenchment

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

2002 2006 2010 2014

change in cyclically-adjusted structural balance (sign reversed), % of potential GDP


IMF Forecast

Eurozone Problems

• The immediate problem is one of excessive public deficits and debts in some countries

• The longer-run problem is one of low external competitiveness and deficits in those same countries

• Austerity in Greece, Ireland or Portugal (but also in Spain or Italy) can help reduce both sets of deficits, but only at the cost of a prolonged period of very low growth

• Policy makers running at a different speed to markets• Emerging policy reaction appears to accept the possibility of a Greek

default but not of a Greek devaluation; focus is protecting banks and on stopping contagion

• Should permit slow though positive growth in 2012, but …• Policymakers could be over-taken by events; cannot rule out the breakup

of the Euro area

There is a significant risk of financial contagion

0 200 400 600 800

Japan

Spain

Italy

US

UK

Germany

France

Rest of world

Greece

Ireland

Portugal

Spain

Italy

World : Bank exposures to PIIGS

US$ billion, 2011Q1Source : Bank for International Settlements

• US appears to be teetering on the brink of recession– Labour market data has been particularly weak

– House prices are falling sharply once more

• The Fed has launched ‘Operation Twist’, selling shorter-term assets to buy long-term US treasuries. It will also reinvest principal payments from its agency holdings in agency mortgage-backed securities, in an attempt to support the housing market

• Operation Twist has had a modest effect on long-term rates which in turn should provide a modest boost to the economy. But more QE may still be on the way

• Emerging markets are still reporting high inflation rates and there are signs of property bubbles in some markets

• Policy has been tightened aggressively and there are signs that growth is slowing…but might this need to be reversed?

There are other global concerns too

US situation was fragile with unemployment high…

-7

-6

-5

-4

-3

-2

-1

0

0 3 6 9 12 15

Quarters from pre-recession peak

% c

han

ge

in e

mp

loym

ent

fro

m p

eak


This cycle

2001/021973/74

1981/82

1990/91

And house prices falling again

-25

-20

-15

-10

-5

0

5

10

15

20

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

% year

Source: S & P

US: House Prices*

* Case-Shiller index

Inflation at uncomfortable levels in emergers

-2

0

2

4

6

8

10

12

14

16

18

20

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

% year

China

Source: Oxford Economics

BRICS: Consumer prices

India (CPI)Brazil

Russia

…and consumption growth has eased…..

-20

-15

-10

-5

0

5

10

15

20

1997 1999 2001 2003 2005 2007 2009 2011

% year

Korea (Wholesale/Retail)

Source: Haver Analytics

Emerging Asia: Retail sales & consumption

Volumes (3 month moving average)

China

Thailand

The UK recovery has been a bumpy ride so far

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2006 2007 2008 2009 2010 2011

GDPConsumer Spending

UK GDP & Consumer Spending% per quarter


Post-Royal Wedding Bounceback Has Stalled

85

87

89

91

93

95

97

99

101

103

105

2007 2008 2009 2010 2011

UK: Output Indices2007=100

Source : ONS

Services

Manufacturing

…and confidence to deteriorate sharply…

-45

-40

-35

-30

-25

-20

-15

-10

-5

0

5

2005 2006 2007 2008 2009 2010 2011

60

70

80

90

100

110

120

UK: Consumer & business confidence% balance

Source : Haver Analytics

Consumer - GfK NOP(LHS)

Business - EC(RHS)

LT average = 100

…now surveys point to a renewed slowdown

25

30

35

40

45

50

55

60

65

2005 2006 2007 2008 2009 2010 2011

UK: Purchasing managers surveys% balance*

Source : CIPS/Markit

Construction activity

Manufacturingactivity

Services businessactivity

*value over 50 indicates rising activity

…intensifying the squeeze on household finances

50

60

70

80

90

100

110

Consumer Spending Power Indicator2007 = 100

Source : Oxford Economics

Household debt levels remain very high…

90

100

110

120

130

140

150

160

170

180

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

UK: Household debt-to-income ratio% of household disposable income

Source : Haver Analytics, Oxford Economics

Forecast

…unemployment is rising…

2

3

4

5

6

7

8

9

10

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

%

Claimant count

ILO

UK: Unemployment

Forecast

Source: Oxford Economics

Plenty of cash on corporate balance sheets…

-6

-4

-2

0

2

4

6

8

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

UK: Corporate sector financial balance% of GDP, 4QMA


Financial corporations

Non-financial corporations

Low-ish borrowing costs…

-1

0

1

2

3

4

5

6

7

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

UK: 10 Year Corporate Bond Yields(calculated using the GVA deflator, %)

Source : Bank of England, ONS, Oxford Economics

Nominal

Real

Company borrowing has stalled

-10

-5

0

5

10

15

20

25

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

UK: Net lending to UK PNFCs£bn


Domestically generated inflation is under control but …

UK: CPI Inflation Measures

0

1

2

3

4

5

6

CPIY

CPI Headline

CPIO

Inflation set to rise further…

0

1

2

3

4

5

6

2005 2006 2007 2008 2009 2010 2011 2012

UK: Contributions to CPI inflation% year

Source : Haver Analytics/Oxford Economics

Petrol

Food

Domestic energy

Other

Forecast

Policy Options?

Fiscal policy

• Automatic fiscal stabilisers will provide support if weakness continues – government spending on social benefits, etc will rise and tax revenues will fall

• Temporary VAT cut - unlikely

• Bring capital spending forwards – distinct possibility

Monetary Policy

• Another round of QE – just happened

• A public sector small business bank – unlikely

• Credit Easing – likely, not sure in what form yet

Other Policies

• Planning liberalisation – on the way

• Broader business support – likely to cost too much

China is becoming the world’s major export market

0

50

100

150

200

250

300

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Advanced Economies Exports of Goods$USbn


to USA

to China

Emerging Markets Increase in Importance

(Exports of goods only)

UK Germany France Italy USA Japan Australia

China as a % of exports of goods 2.2 4.9 2.9 2.6 7.2 19.7 26.0USA as a % of exports of goods 11.3 5.2 5.0 5.8 n.a. 15.5 3.8

% Growth in Exports to China 2003/4-2010/11 152.3 174.0 217.7 162.1 207.2 148.8 829.3

% Growth in Exports to USA 2003/4-2010/11 -2.3 -5.3 -0.9 7.7 n.a. 4.8 36.9

…. But structural change is slow• China is a mixed blessing to advanced economies:

– New export opportunities but..– A competitive threat– Pressure on commodity prices– Has a long way to go before it looks like a western economy

• Still heavily export dependent• Structural change will provide new & different opportunities• Same is true of many other emerging markets• Over-reliance on investment? Threat of a crash?

25

30

35

40

45

50

2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

China% of GDP (constant prices)


Investment

Consumer Spending

Bond

mar

ket s

tres

s

Eurozone financial contagion■ Confidence in peripheral countries’ finances

deteriorates further, leading to an eventual disorderly default

■ Pressure intensifies to cut budget deficits rapidly in all major economies

■ Rising unemployment and business failures feed back into banking

■ New wave of loan losses for global banks leads to tighter credit conditions

■ Limited scope for monetary policy offset

Corporate confidence

Downside risks to Oxford Economics’ forecast

China/Emerger hardlanding

■ Flight from risk leads to falling share & property prices

■ Commercial property crash & external weakness leads to banking sector stress

■ Investment slumps in China as government recapitalises banks

■ Asian supply chain effected as domestic engine of growth stalls

Oxford forecast■ Gradual rise in business confidence

encourages corporates to invest ■ But weak banks & excess capacity limit

scale of investment recovery■ Consumer spending recovery limited by

pace of job growth and fiscal retrenchment

■ But recovery strong enough that fiscal crisis remains contained

■ Controlled debt restructuring

Recession in USA■ Risk premiums rise and global stock markets

tumble again with falls in business confidence■ Continued political deadlock between

Democrats and Republicans leads to fiscal paralysis

■ Slump in labour market fuels household retrenchment and consumption falls

■ Renminbi rises sharply as trade pressures grow

Bond

mar

ket s

tres

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Oxford forecast

■Gradual rise in business confidence encourages corporates to invest

■But weak banks & excess capacity limit scale of investment recovery

■Consumer spending recovery limited by pace of job growth and fiscal retrenchment

■But recovery strong enough that fiscal crisis remains contained

■Controlled debt restructuring

Bond

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Bond

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Eurozone financial contagion

■Confidence in peripheral countries’ finances deteriorates further, leading to an eventual disorderly default

■Pressure intensifies to cut budget deficits rapidly in all major economies

■Rising unemployment and business failures feed back into banking

■New wave of loan losses for global banks leads to tighter credit conditions

■Limited scope for monetary policy offset

Bond

mar

ket s

tres

s

























Bond

mar

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Recession in USA

■Risk premiums rise and global stock markets tumble again with falls in business confidence

■Continued political deadlock between

■Slump in labour market fuels household retrenchment and consumption falls

■Renminbi rises sharply as trade pressures grow

Bond

mar

ket s

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Bond

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■Flight from risk leads to falling share & property prices

■Commercial property crash & external weakness leads to banking sector stress

■Investment slumps in China as government recapitalises banks

■Asian supply chain effected as domestic engine of growth stalls

Investor Implications

• Inflation on the wane….but what about QE II?• Emerging markets look strong – but already on the slide/danger of a

bubble (especially in real estate)• Corporate finances and profitability surprisingly good in western

economies – by and large – but confidence lacking – and detailed research needed

• Government bond rate normalisation will happen but not for several years

This document is for information purposes only. The information herein is believed to be correct, but cannot be guaranteed, and the opinions expressed in it constitute our judgement as of this date but are subject to change. Reliance should not be placed on the information and opinions set out herein for the purposes of any particular transaction or advice. Oxford Economics cannot accept any liability arising from any use of this document.

Neil blake final_presentation

Economy & Finance

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