1st December 2010
In a roundup of 2010 and what the new year holds in store, two Schroders economists points out that at the moment it looks "very much a case of déjà vu", with 2010 ending pretty much the way it started, with a rally in markets and a world economy generally on the mend.
An indication of just what a rollercoaster of a year 2010 has been is that its early promise had evaporated by springtime, with the euro crisis erupting and the world economy showed signs of slowing down. Fears quickly grew about a double dip and there was heavy focus on stimulation by central banks.
While the economists, Keith Wade and Azad Zangana, are generally positive on outlook, they warn that austerity will "easily taking pole position as the main barrier to global growth" over 2011. The troubled, peripheral parts of Europe – Greece, Ireland, Spain and Portugal – will remain a major focus for markets as keep a keen eye on the impact of the unwinding of the huge borrowing such countries have indulged in over the last decade.
"This tightening of fiscal policy is going to be a headwind to global growth, but particularly in the UK and eurozone where we expect to see a slowdown in economic activity. It's a key question as to whether they can withstand tightening of fiscal policy," they warn.
The Ireland crisis has led to renewed focus by markets on the peripherals, with Portugal now very much in the sight of markets, as this Guardian article highlights.
Quantitative easing (QE) was a major theme over 2010, with the US notably engaging in a fresh round of stimulation. Wade and Zangana, chief economist and European economist at Schroders respectively, say the "surprise" with US QE2 was the impact it had on the rest of the world, with currency appreciation and an ever increasing risk of growth stalling elsewhere lead to the start of the ‘currency wars'.
There has been considerable criticism of US QE2 as highlighted by this Nuwire Investor article, with emerging countries like China accusing the US of engaging in the stimulation primarily to weaken the dollar.
Beyond the fall in bond yields and the dollar, Wade and Zangana do not see there being much further impact from QE2, certainly not while banks refuse to lend and more importantly while households and corporates continue to have little appetite for borrowing. "Emerging markets have fast become the destination for investors forced to search for yield. However, the creation of huge capital flows is causing liquidity problems and inflation is beginning to pick up too," they add.
The focus of the currency war has really been on the fall in the dollar, but against that there has been a rise in the euro, the yen and the Australian dollar. "That increase in currencies is going to squeeze growth in the eurozone, Japan and Australia, so there's a real battle going on where everybody is trying to devalue their currency in order to get a bigger share of a shrinking pie," says Wade.
As to who will ultimately ‘win' the currency war, the economists reckon that at the moment the US is on top, while Europe, where there is a desperate need for growth is fast becoming the biggest casualty. They note that it is only recently with the crisis in Ireland that the euro has begun to fall again providing some relief to the embattled region.
China, meanwhile, is benefiting from the fall in the dollar with a currency that is becoming cheaper against the euro and the yen. But, as Wade and Zangana stress, the benefits are not without problems: "Big capital inflows are creating liquidity problems and asset bubbles, not to mention inflation – and that's something the authorities have to deal with in 2011."
Looking ahead to the new year, the economists expect to see the recovery continue globally, but especially in the US, which has been boosted by strong profits and healthy balance sheets in the corporate sector. The US therefore should see increased capital expenditure and employment, raising growth in the world economy as confidence returns to US consumers.
In emerging markets, an enviable fiscal position capable of increasing expenditure in infrastructure will continue to boost growth.
The outlook for Europe and UK however is more muted, with Wade and Zangana expecting them to experience a slowdown, mainly because of the spending cuts and tax increases, which will begin to bite into 2011.
Their view on the UK is echoed by Euroframe, a group of the ten of the most respected economic forecasting and research institutes in Europe. As Investment International reports, Euroframe expects the British economy will grow below trend in 2011 and the year beyond but could be worse if the eurozone debt crisis escalates, economists are warning.
The Organization for Economic Co-operation and Development, meanwhile, reckons the global economic recovery is shifting down a gear as the U.S. economy rebounds less quickly than expected and growth in emerging countries moderates. According to Reuters, the OECD believes several factors suggest that the outlook might be downgraded further, citing among others global currency tensions and a possible debt crisis in Europe.