World recovery increasingly dependent on US growth engine

Global Economic Outlook by Fitch

Fitch Ratings says in its latest Global Economic Outlook (GEO) that global growth is uneven, but will strengthen in 2015 and 2016. A buoyant US economy is the main engine of global growth, while the recovery continues to falter in the eurozone, Japan and many large emerging markets. Overall, the global growth outlook has marginally weakened since September's GEO and risks remain skewed to the downside.

Fitch's latest forecasts for world GDP growth (weighted at market exchange rates) are 2.5% in 2014, the same as in 2013, picking up to 2.9% in 2015 and 3% 2016. Compared with the September GEO the forecasts are 0.1pp lower for 2015 and 2016, mainly due to emerging markets (EM).

For the US economy, Fitch maintains its forecast of robust GDP growth of 3.1% in 2015 and 3% in 2016, the strongest among major advanced economies (MAE), up from 2.3% in 2014. The economy expanded at a rapid annualised 3.9% in 3Q14. Private consumption will be a key growth driver, supported by rising household disposable income and a strengthening labour market. Unemployment dropped to 5.8% in October, below the level originally targeted by the Fed as a trigger for raising interest rates and getting close to Fed estimates of the "natural rate".

The eurozone recovery remains fragile, with weakness widespread across member countries in both the periphery and the core. The last two quarters witnessed a marked slowdown in Germany, where yoy growth sagged to 1.2% in 3Q14 from 2.3% in 1Q14. A pick-up in German demand will be vital for the eurozone outlook. We now project eurozone growth of 0.8% in 2014 and 1.1% in 2015, down 0.1pp and 0.3pp respectively from September's GEO. Growth for 2016 is unchanged at 1.5%. Despite an environment of highly accommodative ECB monetary policy and broadly neutral fiscal position, growth is being weighed down by private sector deleveraging, structural bottlenecks and spill-over from geopolitical risks. High unemployment will persist and remain above 11% until 2016.

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The gap between headline and core inflation will widen globally in the near-term as lower energy prices increase downward pressures on headline inflation rates. Fitch's latest projections for eurozone inflation are 0.6% in 2014, 0.9% in 2015 and 1.3% in 2016. Under our base case the eurozone will avoid protracted deflation. But it remains a meaningful risk, in view of current low inflation, weak demand and the potential for self-reinforcing dynamics, given below-target inflation expectations.

Lower oil prices will boost global growth. Fitch has cut its forecast for Brent oil prices to USD100pb in 2014, USD83pb in 2015 and USD90pb in 2016, following the sharp drop in recent months and OPEC's failure to take action to reverse it. We expect prices to rise from current levels as demand picks up, in line with our assumption of stronger global GDP growth in 2015 and 2016, and lower production. A 20% fall in oil prices will boost the level of global GDP by around 0.3% over two years, but will create big losers as well as winners. This edition's alternative scenario explores the impact of a scenario of oil dropping a further 20%.

EM face larger and more persistent weaknesses than previously expected. Fitch forecasts EM growth to slow to 4% in 2014 from 4.7% in 2013, before edging up to 4.1% in 2015 and 4.5% in 2016. Brazil entered a technical recession earlier this year and Fitch expects another challenging year in 2015 with GDP growth of just 1%, as the new government tightens economic policies to address the imbalances that have developed in recent years and to revive confidence. Russia will fall into recession in 2015 with GDP contracting 1.5% under the combined weight of western sanctions, sharply lower oil prices and tightening financial conditions. Investment remains firmly in negative territory, real wage growth is close to zero and household demand is marking time.

China's slowdown is structural and we expect GDP growth to moderate to 7.3% in 2014, 6.8% in 2015 and 6.5% in 2016 as it gradually rebalances while seeking to contain leverage. India will be the only BRIC country where growth picks up in 2014 to 5.6% and accelerates to 6.5% in 2015 and 6.8% in 2016, owing to the government's reforms to the business environment.

Japan's unexpected economic contraction in 3Q14 has led Fitch to cut its short-term GDP forecast. We now forecasts 2014 real GDP at 0.8%, a downward revision of 0.6pp from September. However, we believe some of the drag is temporary and that a broader range of factors remain conducive to stronger growth, and on this basis have revised up our 2015 forecast to 1.5% from 1.3%. The 2016 forecast is unchanged at 1.3%. Higher wage growth is central to Japan's prospects of sustaining higher real and nominal GDP growth.

Growth in the UK has been strong and broad-based. Fitch maintains its forecast that growth will slow from 3% in 2014 to 2.6% in 2015 and 2.3% in 2016, as it converges on its medium-term potential rate of 2%-2.25%. The base case is for nominal wage growth to pick up as labour market slack is absorbed and the currently weak productivity growth improves, in line with previous cyclical recoveries.

An absence of inflationary pressures, despite tightening labour markets, implies the Fed and Bank of England will follow a slower monetary policy tightening path. Key global interest rates will remain low over the medium term, below 2% at least until 2016. Our current base case is for the ECB to hold off quantitative easing (QE) involving sovereign bonds, given our baseline for a gradual recovery, stable core inflation and high institutional hurdles to QE.

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