Schroders’ Keith Wade and colleagues see opportunities and threats in latest outlook

US growth could improve, but Europe’s deteriorate, according to Schroders chief economist and strategist Keith Wade, European economist Azad Zangana, and economist James Bilson.

We are upgrading our forecast for US growth in response to signs that the drag from last year’s inventory build-up is fading whilst orders are picking up. Tighter fiscal policy remains a headwind, but we are more confident that this will be offset by stronger private sector spending, primarily from the corporate sector.

The upward revision is most apparent in our forecast for 2013 year-end growth in the US which is increased to 2.6% y/y from a previous forecast of 2%. The calendar year forecast has risen by less (from 1.9% to 2.1%) due to a strong base effect at the end of last year when GDP unexpectedly fell.

Stronger growth is also apparent in our forecast for China (revised up to 8.2% from 8%), but overall global growth at 2.4% has not significantly changed since our last review in November last year. This is primarily due to a downward revision to Europe with our forecast for the Eurozone being cut to -0.6% (from -0.3%) whilst the UK is reduced to 0.6% (from 1%).

The appreciation in the euro contributed to the downgrade as we are now using a stronger currency assumption for 2013. The single currency region is, in this respect, a loser in the recent currency wars. The latest purchasing managers indices (PMI) surveys reinforce these trends with the US and China moving decisively into expansion territory whilst the Eurozone continues to contract.

Currency moves have also contributed to a change in the forecast for Japanese growth following the depreciation of the yen. We have increased our forecast to 1% for 2013 (from 0.4%) as Japanese firms are expected to gain market share.
Looking further ahead, we see global growth gathering pace to 3.2% in 2014 as the US and emerging markets continue to improve and European growth begins to lift. However, this is still modest by pre-crisis standards when the world economy was expanding at more than 4% per annum.

Against this backdrop inflation is expected to remain relatively subdued. We do expect a more aggressive Bank of Japan to achieve some success in lifting the economy out of deflation, but we do not expect price increases to reach the new 2% target.

More generally, global growth is not strong enough to put significant upward pressure on commodity prices or wages. In the near term, economic slack is available to absorb increased demand and inflation expectations remain well-anchored. Our global inflation forecasts are unchanged at 2.7% for this year and 2.6% next.

Further out, we share the concern that inflation will be higher than expected – a consequence of money printing around the world. The very public debate amongst central banks is an indication that inflation is no longer the priority amongst policymakers. For example, in a break with the past, the latest Bank of England (BoE) Inflation Report showed inflation was not expected to return to target over the medium term. Meanwhile, the minutes of the monetary policy committee showed that there was increasing support for looser policy from some members including the governor Mervyn King.

Despite increased tolerance for inflation, stronger growth in the US will cause investors to question the Federal Reserve’s commitment to easy money. The unemployment rate is set to remain above the 6.5% target, however, better growth will hasten the debate over just how accommodative policy should be.

Given the concerns already expressed by members of the FOMC (the Fed’s policy setting committee), we have scaled back our forecast for Large Scale Asset Purchases which we now expect to end in the first quarter of 2014. That decision will probably be taken by a new Fed chair as we expect Ben Bernanke to step down at the end of this year. Our working assumption is that he will be replaced by Janet Yellen, who will continue the tradition of the central bank being headed by a dove.

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