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ROM THE ECONOMIST INTELLIGENCE UNIT

The world economy continues to stabilise. Although the effects of the financial and economic crisis are still being felt and trading conditions remain difficult for many companies, signs of recovery are increasingly visible. The Economist Intelligence Unit has raised its forecast for global growth. We now expect world GDP at purchasing power parity to grow by 3.2% in 2010, up from 2.9% in our forecast last month. This reflects, in particular, a higher forecast for OECD growth. Other key changes to our forecast are for US interest rates and some prices for metals.

As we highlighted last month, one of the main reasons for the improving global picture—and at the same time one of the chief causes for concern—is that policy stimulus is working. In the past year governments and central banks have taken unprecedented measures to tackle the crisis. Initially, the most urgent task was to stabilise the financial system and keep major banks afloat. Now stimulus programmes, including interest-rate cuts and fiscal packages, are feeding through into the wider economy. Recent data show many countries emerging from recession thanks to these policies, with parts of Asia rebounding particularly strongly.

Cyclical factors are playing their part. This time last year, many businesses shuttered plants or halted production in anticipation of lower sales, using up their existing inventories rather than building up excess stocks of new goods. This inventory "drawdown" amplified the decline in GDP. As global conditions improve, however, we expect businesses to start restocking—or at the very least to reduce inventories more slowly. This will have the opposite effect of boosting economic growth temporarily.

Post-stimulus correction?

The big concern is what happens when the effects of stimulus wear off. Government spending cannot support growth indefinitely, as the increasingly politicised debate in many countries about rising budget deficits illustrates. There is therefore a high risk that the recovery could weaken in 2011 if stimulus is withdrawn. Although we are not forecasting a slowdown for the world economy as a whole, we do expect US growth to decelerate in 2011 for precisely this reason.

The recovery story also needs qualifying in other respects. Although financial markets have stabilised, with equity prices rallying strongly in recent months, credit conditions remain difficult. Banks have continued to tighten lending standards, and while large companies have switched to issuing bonds in record amounts to meet their funding needs, small and medium-sized firms will find it hard to obtain credit. Demand for credit will also remain soft, as many households and companies will focus on rebuilding their finances for several years. They will not consume or invest as much as before, and therefore will borrow less.

Partly as a result, world economic growth will not return quickly to its pre-crisis trend level. This will make it harder for those made unemployed during the crisis to find new jobs, and there is a high chance that many countries will experience "jobless" recoveries. We expect the unemployment rate in the US, for example, to remain above 9% in both 2010 and 2011. The longer unemployment remains high, the more likely it is, in turn, that banks will suffer further problems from defaulting borrowers.

US: Inventory boost, but fears of a double-dip slowdown

We have raised our US forecast for 2010 considerably. We now expect the economy to grow by 2.4% in real terms, up from 1.7% in last month's forecast. Yet the "upgrade" is deceptive, as it mainly reflects revised assumptions about inventory adjustments rather than a change of heart about the structural health of the US economy. In particular, we still think private consumption—which accounts for around 70% of GDP—will recover slowly and fitfully. We also assume that the Obama administration will not push through a second large fiscal package, in part because of political resistance in Congress and rising voter concern about the country's public finances. We now also think the US Federal Reserve will raise interest rates slightly earlier (in the third quarter of 2010, instead of in 2011). As a result of these factors, our latest forecast envisages a more pronounced "W-shaped" recovery than before, with growth expected to weaken to 1.1% in 2011.

Western Europe: Slightly improved euro zone prospects

Euro zone economies continue to struggle, and we still expect output in the region to contract by 4.1% this year. Banks are heavily exposed to emerging markets in eastern Europe, where the effects of the downturn have been severe. However, export prospects are no longer so dire and policy stimulus is proving helpful. Recent GDP data for Germany and France showed a return to growth. We now expect real GDP in the euro zone as a whole to expand by 0.8% in 2010, up from 0.5% in last month's forecast.

The UK's prospects remain grim. The economy will contract by 4.6% this year and grow by just 0.5% in 2010. The drastic deterioration in the public finances, now a major political issue, also clouds the country's medium-term recovery prospects because of its implications for fiscal policy, which will have to be tightened.

Emerging markets: Asia leads the recovery

In emerging markets, the picture is mixed. While much of eastern Europe is still extremely weak, prospects in parts of Latin America are improving. Some countries are benefiting from strong Chinese demand for raw materials, while Brazil is weathering the downturn particularly well thanks to a strong financial system and large internal market. Most striking, however, is the upturn in emerging Asia. Given the region's traditional dependence on exports, this seems surprising. But big fiscal stimulus programmes are supporting growth. The corollary is that prospects may weaken once the effects of stimulus fade, unless exports or private-sector demand can take up the slack.

Our forecasts for the Middle East and Africa are little changed. Lower oil prices compared to last year, combined with weaker OECD demand for exports and the bursting of property bubbles, have hurt the Middle East and North Africa, where growth will slow sharply to 0.8% this year. But rising oil prices and output, and an improving global economy, will lead to a strong rebound in 2010 and 2011.

Exchange rates: Dollar weakness

The weakness of the US dollar, now at around US$1.50 to the euro, has been headline news. This weakness partly reflects the US's ultra-low interest rates and a sharp rise in investors' risk appetite, which has reduced the safe-haven appeal that supported the dollar late last year. As a result, we now forecast an average exchange rate of US$1.42 to the euro in 2010 (compared with US$1.39 in our previous forecast). As investors anticipate higher US interest rates in 2010, the dollar is likely to strengthen a little over the course of the year. The European Central Bank is expected to tighten monetary policy more slowly than the Fed, which should also support the dollar. We have also revised our dollar-yen forecasts, and expect the Japanese currency to average ¥90 or stronger against the dollar for the next five years. Overall, the dollar's trajectory looks highly uncertain and will be volatile.

Commodities: Higher metal prices

Our oil-price forecast is only slightly changed from last month. We still expect a barrel of oil to cost an average of US$74 in 2010. Although demand is weak and global stocks are at all-time highs, a number of factors should support prices. They include optimism about the global recovery, the effects of monetary and fiscal stimulus, and OPEC's imperfect efforts to restrict output. Prices will be softer on average in 2011 as the effects of economic stimulus fade, although our new forecast of US$70/b is still slightly higher than before (we were forecasting US$67/b previously).

The more dramatic commodities story is in metals, where we have sharply revised up our price forecasts for copper, aluminium and gold. Copper will average US 281 cents/lb in 2010, a 13% increase on our previous forecast, and aluminium has been revised up 26% to US$1,951/tonne. These changes reflect strong price rises in the past two quarters, driven by huge increases in Chinese imports. However, a concern is that China appears to have been taking advantage of low prices to build stocks, and may buy less as prices rise. Meanwhile, the price of gold has risen to around US$1,060/troy oz, driven by concerns about inflation, a weakening dollar and volatility in other asset markets. We expect gold to average US$1,044/troy oz next year, easing to US$976/troy oz in 2011.


World economy: Forecast summary
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Real GDP growth (%)
World (PPP exchange rates) a 4.4 5.0 5.0 2.8 -1.3 3.2 3.4 3.8 4.0 4.1
World (market exchange rates) 3.6 4.0 3.8 1.7 -2.5 2.3 2.3 2.8 3.0 3.0
US 3.1 2.7 2.1 0.4 -2.4 2.4 1.1 1.9 2.3 2.3
Japan 1.9 2.0 2.3 -0.7 -6.2 1.3 1.0 1.1 1.0 0.9
Euro area 3.5 3.0 2.6 0.6 -4.1 0.8 1.0 1.5 1.8 2.0
China 10.4 11.6 13.0 9.0 8.2 8.6 8.4 8.5 8.2 8.2
Eastern Europe 5.6 7.3 7.3 4.7 -6.0 1.6 3.5 4.1 4.2 4.1
Asia & Australasia (excl Japan) 7.2 7.9 8.7 5.5 3.7 5.7 6.3 6.5 6.4 6.5
Latin America 4.9 5.6 5.5 3.9 -2.9 2.7 3.3 3.7 3.8 3.9
Middle East & North Africa 6.4 6.1 5.6 6.0 0.8 4.4 4.4 4.8 4.7 4.9
Sub-Saharan Africa 6.6 6.6 6.8 4.5 -1.7 3.0 4.9 5.0 4.9 4.9
World trade growth (%) 7.5 9.1 7.5 3.6 -9.4 3.7 4.6 5.2 5.7 5.9
World inflation (%; av) 3.0 3.2 3.4 4.9 1.2 2.1 2.6 2.8 2.8 2.9
Commodities
Oil (US$/barrel; Brent) 54.4 65.4 72.7 97.7 62.0 74.0 70.0 80.0 82.5 89.5
Aluminium (US$/tonne) 1,900 2,594 2,661 2,621 1,671 1,951 2,017 2,100 2,250 2,350
Copper (US cents/lb) 167 306 322 316 226 281 299 300 305 310
Gold (US$ /troy oz) 445 604 697 870 960 1,044 976 900 850 825
Exchange rates (annual av)
¥:US$ 110 116 118 103 94 90 89 88 87 86
US$:€ 1.25 1.26 1.37 1.47 1.40 1.42 1.40 1.42 1.44 1.45
a PPP = purchasing power parity
Source: Economist Intelligence Unit.

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