Third Quarter 2008 Forecast

The G7 Economies: Caught Between a Rock and a Hard Place

 At the half way point in 2008, world financial markets remain in a state of confusion, with investors trying to assess the implications of credit-led deflation amid worries about the probability of further credit-related writedowns, and commodity-led inflation as soaring energy and food prices fuel fears that central banks will be forced to tighten policy at the very point that the global economy is losing traction.

Accommodative monetary and fiscal policies in the world’s leading economies are combining with sustained above-trend growth in emerging-market countries, led by China, India, Russia and the Gulf States, to push up inflation rates to levels not seen since the early 1990s.  The immediate concern for investors is that the recent marked decline in global business and consumer confidence confirmed by surveys indicates the downside growth momentum is accelerating.  While the deteriorating trade-off between economic growth and accelerating inflation has been apparent for some time, the intensification of these trends is a cause of growing concern.

An emergency rescue plan announced by the US Treasury, to support troubled mortgage agencies Fannie Mae and Freddie Mac, which together hold or guarantee $5,000bn of US home loans and in which Asian central banks feature among the biggest holders of their debt, has temporarily helped stabilise equity markets, but investors appear unconvinced by the government-orchestrated bail-out.  Much of the deceleration in growth in the G7 countries is occurring in Europe and Japan, but industrial production across the world economy shows increasing signs of softening.

Growth Forecasts for the Advanced Industrialised Economies
(% change in real GDP over a year ago)
 
2007F
2008F
2009F
United States
2.2
1.6
2.1
Canada
2.7
0.9
2.3
Japan
2.0
1.4
1.4
Euro area
2.6
1.8
1.3
-Germany
2.6
2.2
1.6
-France
2.1
1.8
1.6
-Italy
1.4
0.5
1.0
United Kingdom
3.0
1.7
1.2
Developed markets
2.5
1.7
1.7
Emerging markets
7.5
6.2
6.2
F is forecast.
Source: JP Morgan, June 2008

Emerging-Market Economies: Growth Outlook Still Favourable

 Whereas in the advanced industrialised countries there is little evidence of accelerating wage inflation, given an expected increase in unemployment as companies cut costs and put investment plans on hold, higher inflation in emerging-market economies is being matched by significant upward pressure on wage costs.  Real interest rates, however, remain negative in many emerging markets, particularly in Asia where central banks have generally been slow to tighten policy, and the Middle East where the ability of the GCC states to respond to rising inflation is constrained by their currency pegs with the dollar.

In contrast, central banks in Latin America and emerging Europe generally moved earlier to tighten policy, to contain inflationary pressures.  With dollar weakness showing few signs of ending soon, as the Federal Reserve finds itself unable to raise short-term interest rates, most emerging-market currencies continue to strengthen against the dollar.  At the same time, emerging market GDP growth and earnings projections for 2008 remain favourable, even as the threat of recession in the developed world continues to grow.
 
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