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GLOBAL ECONOMY

The IMF cut its global growth forecasts and indicated the downside risks to the world economy have intensified. Global GDP is now forecast to rise by 3.3% in 2012, significantly lower than the 4% forecast in September. The Fund’s chief economist Olivier Blanchard warned that“the world recovery, which was weak in the first place, is in danger of stalling. The epicentre of the danger is Europe, but the rest of the world is increasingly affected”.

The IMF now forecast the Eurozone to fall into a ‘mild’recession in 2012 with GDP falling by 0.5%. Forecasts for Italy and Spain have been hit particularly hard, reflecting the impact of higher bond yields, bank de-leveraging and continued fiscal austerity. Both economies are expected to contract by around 2% in 2012. Analysts warned that the gloomier growth outlook may imply even more fiscal austerity will be needed to meet fiscal targets and emphasised the importance of structural reforms to boost growth.

Leading indicators of Eurozone activity struck a more upbeat tone, with relative strength in Germany. The closely watched survey of Purchasing Managers rose unexpectedly to 50.4 in January, driven by robust growth in Germany and a modest expansion in France. Any reading above 50 indicates economic activity is expanding. Also in Germany, the IFO business climate index picked up further in January to the highest level since August.

The bond markets shrugged off the IMF’s downbeat assessment, with Italy and Spain both managing to successfully conduct bond auctions. Both countries have taken advantage of lower short term interest rates to issue short-term debt and have seen ten-year bond yields stabilise at around 6.25% and 5.5% respectively, well below the levels seen in November and December. Elsewhere in the periphery, the news was less upbeat. Portuguese ten-year bond yields are back at Euro-era highs over growing fears that another bailout programme will be needed.

Negotiations over the extent of Private Sector Involvement (PSI) in Greece’s debt restructuring deal failed to reach agreement. The International Institute for Finance, which is negotiating on behalf of private bondholders, presented a ‘final’ offer to the IMF and Eurogroup on Monday. The Troika rejected the terms of the deal, and continued to push for more punitive rates in order to improve the chances of Greece returning to a fiscally sustainable path. Meanwhile, the IIF and IMF have both put pressure on the ECB to accept write downs on its €40bn holdings of Greek bonds as part of a final deal. Agreement is needed by early February if a second bailout package is to be put in place in time for Greece to avoid defaulting on a €14.5bn bond redemption due in March.

Monetary policy in the US will remain expansionary for longer than expected. Following Wednesday’s meeting of the Open Market Committee, the Federal Reserve stated that exceptionally low levels of the interest rate were warranted “at least through late 2014”, over a year longer than previously indicated. The dollar weakened and share prices rose on the news. Chairman Bernanke also announced, for the first time, an explicit 2% inflation target and hinted at the possibility of further quantitative easing, or ‘QE3’. Separately, President Obama’s State of the Union address highlighted tax issues as a key battleground for the forthcoming election with a call for the highest earners to pay more.

Japan reported its first annual trade deficit since 1980in 2011 following a year in which the economy has struggled with the impact of a strong yen, the fall out of the Eurozone crisis and the impact of natural disasters on production and supply chains. The current account surplus shrunk to Y139bn (2.2% of GDP), the smallest since 2001.

The start of the year of the dragon was accompanied by news that for the first time more Chinese citizens now live in cities than in the countryside. This historic milestone was reached by the UK in 1851 and the US in 1920.

Iran threatened to pre-empt an EU embargo by immediately halting its oil exports to the region. This week the EU approved a ban on crude oil imports from Iran, effective 1 July. The five-month delay is designed to give Greece, Spain and Italy time to find alternative supplies. Oil analysts warned that if Iran pre-empted the imposition of tighter sanctions, this would elevate concerns about short term supply and push up prices. Oil prices continued to hover above $110 a barrel this week.

UK ECONOMY

The Office for National Statistics (ONS) announced that UK GDP contracted by 0.2% in 2011Q4. The fall was slightly larger than expected and has increased fears of a ‘double dip’ recession – the first since the 1930s. A decline in manufacturing activity of 0.9% on the quarter drove the fall in GDP. By contrast, service sector output, which accounts for more than three-quarters of UK activity, was unchanged. Analysts noted that “with the Eurozone crisis grinding on the near-term economic outlook remains precarious”, but while a technical recession cannot be ruled out, forward looking survey data suggests that activity has begun to pickup so far this year.

The IMF cut its UK growth forecast to 0.6% in 2012. This puts the UK in the middle of the pack of G7 countries, with the US, Canada and Japan growing faster, and the three largest Eurozone countries slower. The downward revision brings the IMF into line with other UK forecasters. Despite the lower forecast and weak Q4 GDP figure, IMF managing director Christine Lagarde appeared to endorse the Government’s fiscal strategy by saying that Britain was not among those countries that could afford to ease up on fiscal tightening in order to stimulate growth.

The Governor of the Bank of England, Sir Mervyn King, has hinted at another round of quantitative easing and indicated the path to recovery is likely to be “arduous, long and uneven”. The Governor said the economic environment was being shaped by tight credit conditions, higher household saving and a slowing world economy. All three were linked to a realisation that debts were too high relative to incomes, he argued. He said that, in addition to providing monetary support, policymakers had to ensure that the banking system regained its health and competitiveness and that the supply capacity of the economy was improved.

The UK’s net public sector debt stock exceeded £1 trillion for the first time (64.2% of GDP) at the end of 2011. However, new borrowing in December fell by more than expected to £13.7bn. The ONS said that tax receipts had been boosted by the bank levy imposed on financial institutions and by last year’s increase in VAT. Meanwhile central government spending had fallen by 0.9%. The government is on track to hit its borrowing target for the year, despite lower than expected growth.