Macro Model Quarterly Forecast Update, 2015 Q1

The global economic outlook for 2015-2016 presents a mixed picture. The Eurozone’s recovery remains weak, with Italy re-entering a recession at the end of 2014 and slower than expected growth in Germany and France.  Eurozone growth is expected to reach 1.1% in 2015 and 1.6% in 2016. Japan’s economy is expected to barely grow by 0.3% in 2015 after entering a technical recession in the 3rd quarter of 2014. The US and the UK are expected to continue their relatively strong expansion in 2015, with GDP growth of 3.3% and 2.5% respectively.

China is expected to slow down towards an average growth rate of 6% in 2017-2021. India is expected to rebound in 2015-2016 towards an annual growth rate of 6.4% in 2017-2021. Meanwhile our outlook for Brazil has worsened yet again with 0.5% growth in 2015, followed by below average growth of 1.7% in 2016. Russia is now expected to spend 2015-2016 in recession with output falling by 3.8% in 2015 and by another 0.4% in 2016, and the risks are heavily tilted to the downside.

In the rest of this report, we take a closer look at the economies of the US, Eurozone, China, Japan, Russia and the UK. In this report, we have also started to publish long term potential growth rate forecasts for 2022-2030.

Table 1: Real GDP Growth

Real GDP growth forecasts in emerging and developed markets

Source: Euromonitor International Macro Model

Note:  forecast change shows upward/downward revision since Oct 2014 forecast.

Table 2: Inflation

Inflation forecasts in Emerging and Developed markets

Source: Euromonitor International Macro Model

Note:  forecast change shows upward/downward revision since Oct 2014 forecast.

All our baseline forecasts (expected or most likely outcomes) below are assigned a 25-30% probability unless stated otherwise. All our most likely downside (pessimistic) and upside (optimistic) scenarios below are assigned a probability of 20-25% unless stated otherwise.

 

The US

The US economy is estimated to have grown by 2.4% in 2014, slightly above its long term potential growth rate of 2.1%. Business and consumer confidence are at the highest levels since 2007, labour markets have improved with the unemployment rate at the end of 2014 declining to 5.6%, and access to credit has increased over the last few years (though it is still significantly tighter than before the 2008 financial crisis).We expect GDP to grow by 3.3% in 2015 (unchanged from the October forecast) and by 3% in 2016 (revised down from 3.2% in the October forecast). GDP growth should slow down to an average annual rate of 2.4% in 2017-2021, and 2.1% in 2022-2030. In our most likely downside scenario the recovery continues to disappoint in 2015-2016, with GDP growth of 2.5% in 2015 and 2.2% in 2016. On the upside, the increase in optimism and lower oil prices boost the economy more than expected, leading to GDP growth of 3.9% in 2015 and 3.6% in 2016.

In our baseline forecast, we still expect inflation to be 1.4% in 2015 and 1.6% in 2016, but in light of the fast drop in oil prices and uncertainty about their future path, an alternative scenario with annual inflation close to 1% in 2015 is becoming almost as likely.

Figure 1: Real GDP Growth in the US

Real GDP Growth in the US

Source: Euromonitor International Macro Model

 

GDP, Consumer Expenditure and Investment

  • The US economy expanded at the fastest rate in 11 years during the 3rd quarter of 2014. Quarter on quarter annualised real GDP growth was 5%, following up on the already fast 4.6% growth of the second quarter. Year-on-year 3rd quarter GDP growth (compared to the 3rd quarter of 2013) was 2.7%, up slightly from the 2.6% in the 2nd quarter. This should be compared to a long-term trend annual growth of 2.1%. The above trend growth has been driven by a solid expansion in consumer expenditure and fast business investment growth. Year-on-year real consumer expenditure growth was 2.7% in the 3rd quarter (up from 2.4% year-on-year growth in the 2nd quarter), while year-on-year real non-residential fixed investment growth was 7.6% (up from 6.7% in the 2nd quarter). Residential investment continued to slow down, with a year-on-year contraction of 0.7% in the 3rd quarter (down from a 1.2% year-on-year expansion in the 2nd quarter).
  • US GDP growth slowed down to a 2.6% annualised rate in the last quarter of 2014, according to the preliminary estimate from the Bureau of Economic Analysis. But growth is expected to improve as the positive effects of cheaper oil filter into the economy, leaving our previous forecast of 3.3% GDP growth in 2015 unchanged.

Leading/Coincident Indicators and Labour Markets

  • Business activity surveys confirm the slowdown in the last quarter of 2014 growth relative to the previous two quarters. The composite (services and manufacturing) Markit purchasing managers’ index (PMI) declined for 6 months in a row in the second half of 2014, though still staying significantly above the 50 threshold for improving business conditions (its average 4th quarter value was 55.6). On a more positive note, consumer and business confidence has increased at the end of 2014 to the highest levels since the start of the great recession.  The University of Michigan consumer confidence index in December reached the highest level since January 2007, the Conference Board consumer confidence index for January was at the highest level since August 2007, while the NFIB small business optimism index reached the highest level since October 2006.
  • The unemployment rate declined in December 2014 to 5.6%, a rate last seen in June 2008. The average 4th quarter unemployment rate was 5.7% (down from 6.1% in the 3rd quarter and from 7% a year earlier), but the health of US labour markets is still questionable due to the large number of potential workers that have dropped out of the labour force. The employment to population ratio in the 4th quarter improved to 59.2% (up from 59% in the 3rd quarter and from 58.5% a year earlier), but it is still below its level in the 2nd quarter of 2009 and far below the pre-crisis peak of 63.3% in the beginning of 2007. Some of this may reflect on- going population ageing, but a similar picture emerges from looking at the 25-54 year old employment rate (which is more robust to demographic effects).

Credit conditions

  • Corporate borrowing conditions remained stable during 2014. The spread between the Moody’s Baa corporate bond yield and the 10 year Treasury bond yield stayed at around 2.2-2.5% during the year, much below the 2008 financial crisis peak of 6%, but still slightly above levels from the mid 2000’s or from the 1990’s.
  • Bank lending surveys suggest that banks continued to loosen credit standards in 2014, though access to loans remains significantly more difficult than before the 2008 financial crisis.
  • Federal Reserve financial conditions indices (e.g. the Cleveland Financial Stress Index) signalled below average financial markets stress throughout 2014, though rising moderately during the second half of the year.

Monetary Policy and Inflation

  • Year-on-year consumer prices inflation declined in the 4th quarter to 1.2% (down from 1.8% in the previous quarter) as oil price declines started filtering in to consumers. Our current baseline forecast still sees inflation of 1.4% in 2015 (revised down from 2% in the October forecast) and 1.6% in 2016 (revised down from 2.2%), returning to an average of 2% in 2017-2021. But there is a large risk that inflation falls significantly below the Fed’s 2% target in the medium-term. Using the difference between nominal and inflation protected Treasury bond yields, bond market investors’ expected average inflation over the next five years has declined in the last two quarters to 1.2% (compared to an average of 1.8% in our baseline forecast).
  • In its December and January meetings, the Federal Reserve maintained its policy interest rate close to zero, but the language in its announcements suggests more strongly that under baseline forecasts it will start raising interest rates in mid-2015. The Fed’s interest rate projections are for short term interest rates to rise above 1% by the end of 2015, approaching 2.5% at the end of 2015 and reaching 3.75% by the end of the decade.
  • The Fed governors’ current projection of an interest rate rise in mid-2015 may have to be revised. With inflation heading closer to 1%, the first interest rate increase may be delayed until 2016. Furthermore, the long-term forecast of the FED is at odds with forecasts based on long term bond yields. The 5 year Treasury bond yield has declined during 2014 by 0.18 percentage points to 1.37% in January 2015. The 10 year Treasury bond yield has fallen in 2014 by almost 1 percentage point to 1.88% in January 2015.This implies a market based interest rate forecast for 2019-2024 of 2.39%, more than 1 percentage below the Fed’s projection of 3.75%.
  • The discrepancy cannot be fully explained by lower inflation expectations. Inflation protected bond rates from January 2015, imply a real (inflation adjusted) average interest rate of 0.17% over the next 5 years and an average real interest rate (nominal rate minus inflation) for 2019-2024 of only 0.37%, well below historical averages and the Fed’s 1.75% forecast. Low long term real interest rate forecasts are often linked to below average GDP growth rates. Using our macro model and the market based long term real interest rate this suggests the risk of a stronger long-term slowdown, with annual GDP growth rates in the US potentially declining towards 1% in the 2020’s.

 

The Eurozone

The Eurozone’s economy continues to struggle, with GDP growth for 2014 estimated at 0.8%. This is significantly below our estimate of the long-term potential growth rate of 1.4%. Business and consumer confidence is still below its pre-crisis average, European banks are still over-leveraged and reluctant to lend, and labour markets improvements have been slow.

The ECB has responded with more creative monetary policy measures such as cheaper loans to banks and plans to purchase almost 1.1 trillion Euros in financial assets. But there are strong doubts on the effectiveness of these new programs. ECB president Mario Draghi emphasized at the latest ECB press conference that monetary policy can stabilise the economy and reduce the likelihood of even lower growth, but it cannot substitute for more fundamental structural reforms in labour and product markets.

European Commission estimates suggest that a comprehensive package of product market deregulation, increasing the efficiency of the tax system and improving workforce skills could raise Italian GDP by 1.3% and Spanish GDP by 4.1% over the next five years.  Yet these structural reforms are usually hard and slow to implement. Furthermore, the Eurozone has essentially gone through two financial recessions in the last 5 years, and these types of recessions almost always cause permanent reductions in potential output, leading to slow recoveries (see “The Recovery from the Global Financial Crisis of 2008: Missing in Action”, September 2014).

We expect Eurozone growth to improve slightly in 2015 to 1.1% (down from 1.4% in our October forecast), reaching 1.6% in 2016 (down from 1.7% in our October forecast). Afterwards we expect the Eurozone economy to expand by an average of 1.5% a year in 2017-2021 and 1.4% in 2022-2030. At this rate, the Eurozone economy is forecast to shrink by another 6.3% relative to the US economy over the next five years, after already starting from a much weaker performance in 2008-2014. Adjusting for demographic trends reduces the differences between the US and the Eurozone. Germany even comes out as having a better recovery than the US. But other key Eurozone economies like France, Italy and Spain are still lagging behind.

Figure 2: Real GDP per Working Age Person in Advanced Economies since 2007

Real GDP per working age person

Source: Euromonitor International Macro Model 

Note: 2007 level normalised to 1 for all countries. 

Upside shocks to the baseline forecast could include a higher than expected boost from low oil prices and a stronger improvement in credit conditions and business confidence (in part due to stronger than expected effects from the ECB’s financial asset purchases). On the downside, financial markets uncertainty caused by Greece’s attempts to renegotiate its debt and disappointment in the effects of ECB monetary policy on the economy could hurt growth in the short-term.

Germany’s GDP growth is expected to decline to 1.2% in 2015, followed by a rebound to 1.6% in 2016. In the most likely downside scenario the German economy slows down to a growth rate of 0.6% in 2015 and 1.1% in 2016. In the most likely optimistic scenario, growth would reach 1.8% in 2015 and 2.2% in 2016.

The French economy should expand by 0.8% in 2015 (revised down from 1.1% growth in the October forecast) and by 1.2% in 2016 (revised down from 1.4% growth in the October forecast). In our most likely downside scenario, growth would decline to 0.2% in 2015 and recover to only 0.6% in 2016. On the upside, growth could improve to 1.4% in 2015 and to 1.8% in 2016.

Italy is expected to continue to underperform other Eurozone economies, with GDP growth of 0.3% in 2015 and 1% in 2016. In our most likely pessimistic scenario, the Italian economy would contract by another 0.5% in 2015 and grow by only 0.2% in 2016. In the optimistic scenario, we see Italy’s economy expanding by 0.9% in 2015 and by 1.6% in 2016.

Spain’s economy will continue as one of the best performers in the EU, with GDP growth of 1.7% in 2015, increasing to 2.5% growth in 2016. On the downside, Spain’s GDP growth could stay at 1.2% in 2015 and increase to 1.9% in 2016. On the upside, the economy could accelerate to 2% growth in 2015 and 2.8% growth in 2016.

GDP, Consumer Expenditure and Investment

  • Eurozone real GDP increased by 0.2% in the 3rd quarter of 2015, compared to 0.1% growth in the 2nd quarter. Year on year real GDP growth in the 3rd quarter was 0.8%, up from 0.6% in the 2nd quarter but significantly below long term trend annual growth of 1.4%. Consumption increased faster than overall output, while investment has stalled. Real consumer expenditure year-on-year growth was 1.1% in the 3rd quarter and 0.8% in the 2nd quarter.  Real investment barely increased by 0.1% over the year to the 3rd quarter, down from 0.6% growth in the 2nd quarter.
  • Looking across the key Eurozone economies, Germany is still growing faster than average with year-on-year growth in the 3rd quarter of 1.2% (up from 1% in the 2nd quarter), the French economy is stagnating with year-on-year growth of just 0.2% in the 3rd quarter (up from 0.1% in the 2nd quarter), while Italy entered a technical recession in the 3rd quarter with year-on-year growth of -0.5% (up from -0.6% in the 2nd quarter). The Spanish economy is outperforming the rest of the Eurozone with year-on-year GDP growth in the 3rd quarter of 1.7% (up from 1.3% in the 2nd quarter).

Leading/Coincident Indicators and Labour Markets

  • We estimate quarterly Eurozone real GDP growth to have declined slightly in the 4th quarter to 0.1%. Business surveys such as the Markit Purchasing Managers’ Index (PMI) continue to signal a small improvement in economic conditions, but also suggest a slowdown towards the end of 2014. The Markit composite PMI (including both manufacturing and services) for the 4th quarter was on average 51.5, above the 50 threshold for improving conditions but at the lowest level since the 3rd quarter of 2013. Business and consumer confidence appear to have fallen in the 2nd half of 2014, based on the European Commission’s  economic sentiment and business climate indices, though they are still hovering slightly above long term averages (but below pre-2008 financial crisis averages).
  • The Eurozone unemployment rate was 11.4% in December 2014, representing a year-on-year decline of 0.4 percentage points. The Eurozone employment rate of 64.4% in the 3rd quarter (which is more robust to discouraged job searchers effects) confirms the picture of slow labour market improvement, with a year-on-year increase of 0.6 percentage points.
  • Differences in labour market performance across the Eurozone in 2014 closely reflect the changes in overall economic conditions. Germany’s unemployment rate decreased year-on-year by 0.3 percentage points to 4.8% in December 2014, while the French unemployment rate increased slightly year-on-year to 10.3%. The Italian unemployment rate increased year-on-year from 12.6% to 12.9% in December, while the Spanish unemployment rate fell by almost 2 percentage points year-on-year to 23.7%.

Credit Conditions

  • Bank lending in the Eurozone continued to contract during the second half of 2014, though at a slower pace than before. Lending to non- financial corporations declined by 1.3% year-on-year in November, compared to year-on-year declines of 2.1% in the 3rd quarter and 2.7% in the 2nd quarter. Lending to households increased by 0.6% in the year to October, similar to the 0.4-0.5% growth rates in the previous 2 quarters.
  • However, the picture is more positive when taking into account other types of borrowing. Total debt of non-financial corporations has started increasing (rising from 81.9% of GDP to 82.4% in the 1st half of 2014) due to greater reliance on financial market debt issues.
  • According to the latest ECB bank lending survey, credit standards continued to ease in the 4th quarter of 2014, though they are still much tighter than their historical average. There was a net easing of 5% for non-financial corporations (up from 2% in the 3rd quarter). For mortgages, there was a net easing of 4% (up from 2% in the 3rd quarter, and for other consumer lending a net easing of 3% (down from 7% in the 3rd quarter).

Monetary Policy and Inflation

  • Inflation in the Eurozone was close to zero in the second half of 2014. Year-on-year December inflation was -0.2%, and our current estimate is that Eurozone inflation was 0.5% for all of 2014. This is far below the ECB’s target of close to 2% inflation. While there have been many concerns that low inflation hurts growth by increasing the real (inflation-adjusted) burden of debt, the link between low inflation and low economic growth in the Eurozone in recent years has been weak. Looking at the last three years, Eurozone inflation has been going down just as GDP growth has been slowly improving. While this is just a potentially noisy correlation, it suggests that there is no automatic causal link between lower inflation and lower economic output in the Eurozone.
  • Inflation has also been higher in some sectors, though still below the 2% target. For example, service sector inflation has been above 1% during the second half of 2014. Year-on-year inflation excluding energy and food costs was 0.7% in December.  Much of the low inflation in the Eurozone is due to positive supply shocks that tend to boost economic growth. The ECB estimates that lower oil prices can explain two of thirds of the decline in inflation excluding energy and food costs since 2011.
  • In its January policy meeting, the ECB launched its own long-term government bond purchase program, commonly known as quantitative easing (QE). The ECB is expected to purchase almost 1.1 trillion Euros in financial assets between March 2015 and September 2016, mostly Eurozone government bonds. More than half of the program was anticipated in advance by financial markets and had already been factored into our forecasts before the announcement. Furthermore, the conservative design of the ECB’s QE program and the weaker links between private sector interest rates and long term government bond markets relative to the US cast significant doubts on the effectiveness of QE in the Eurozone. Therefore, in our baseline forecast QE has only a small effect on the Eurozone economy’s growth (see “The ECB’s QE Program: How Much Does it Matter?” February 2015).

 

China

China’s economy is continuing a very gradual transition into a more consumer and services oriented economy. The economy is estimated to have grown by 7.4% in 2014. GDP growth will continue to slow down to 7.1% in 2015 and 6.7% in 2016 (unchanged from the October forecast), followed by an average growth rate of 6% in 2017-2-2021 and 4.4% in 2022-2030. The key assumption behind this long term forecast is that structural reforms continue, though with an incomplete implementation due political barriers and special interest groups’ opposition. This leads to a forecast that is roughly in the middle between an optimistic completely successful reforms scenario (with 6% annual growth over 2015-2030), and a pessimistic scenario in which China gets stuck in a middle-income trap (with a 4% annual growth rate over 2015-2030).

The government’s attitude to this slowdown is well summarised by the headline from its most recent GDP growth release, reporting the lowest annual growth rate in 24 years: “China’s economy realised a new normal of stable growth in 2014.” China’s leaders seem to have realised that continuing to pile in cheap loans and other subsidies to inefficient state owned entreprises (SOE’s) and local governments, while neglecting private sector firms risks greatly increasing the probability of a major credit crunch and an even bigger economic slowdown.

2015 is expected to see the introduction of significant reforms in the SOE sector, and continued liberalisation in credit markets. These should eventually lead to a more efficient, though slower growing economy. And the slower growth is likely to be more equally shared among China’s households, and is likely to be more sustainable than the excessively credit and investment driven growth of 2008-2013.

The most likely downside risk is a steeper than expected slowdown, with GDP growth of 5.8% in 2015 and 5.5% in 2016. On the upside, higher oil prices and optimism about economic reforms could boost the economy more than in our baseline forecast, leading to growth of 8.3% in 2015 and 7.9% in 2016.

Figure 3: Real GDP Growth in China

Real GDP Growth in China

 Source: Euromonitor International Macro Model

GDP and Other Indicators

  • The Chinese economy’s slowdown continued in the 4th quarter of 2014 with year-on-year growth of 7.3%, unchanged from the 3rd quarter. Overall, annual real GDP growth in 2014 was 7.4%, slightly below the government’s official 7.5% target and down from 7.7% growth in 2013. Investment in fixed assets increased by 15.1% in real terms in 2014 (down from 19.2% in 2013), though the Chinese national statistics office definition of investment tends to significantly overestimate growth rates relative to standard national accounts reporting standards. Retail sales increased by 10.9% in real terms (down from 11.5% growth in 2013).
  • The rebalancing of the economy from investment and manufacturing into consumption and services continued in 2014. Service sector output expanded by 8.1%, compared to 7.3% growth in the industrial sector output, and 4.1% growth in the agricultural and natural resources sector. The services sector accounted for 48.2% of China’s economy in 2014 (up from 46.1% in 2013), while the share of manufacturing declined to 42.7% (compared to 43.9% in 2013).
  • Looking at business surveys suggests a slight improvement in the outlook in the 4th quarter of 2014 and the 1st quarter of 2015.The average composite Purchasing Managers’ Index (PMI) for the 4th quarter of 2014 was 51.4, signalling a slight improvement in business conditions. The average manufacturing PMI for the 4th quarter was 50, indicating no change in business conditions. The average services PMI for the 4th quarter was 53.1, suggesting a stronger improvement in business conditions relative to the rest of the economy.

Credit Conditions

  • Credit continued to expand faster than GDP in 2014. Money supply (as measured by M3) increased 12.2% over the year to December (down from a growth of 13.6% in 2013). The total value of loans outstanding expanded by 13.5% in 2014. Total private sector debt is likely to have exceeded 227% of GDP in 2014, much higher than the level in other countries with a similar level of economic development.
  • Meanwhile, house prices in China’s 70 largest cities fell over the year to December by 4.3%, significantly reducing the value of some of the key collateral supporting such a large lending volume. Chinese businesses are likely to suffer higher financial distress risks in 2015 due to the combination of high debt levels, falling real estate prices and a slowdown in economic growth. Nevertheless, the government is still estimated to have a lot of fiscal space for bailouts and other measures that would limit the consequences of worsening credit conditions.
  • Even if financial conditions remain stable, an inefficient financial system and misallocation of credit are likely to stay significant barriers to growth. Strong credit constraints on the more dynamic private small and medium enterprise (SME) sector remain. The average interest rate on loans to non-financial firms is still close to 7%, more than 4% above official central bank interest rates. Quantity restrictions on loans to SME’s are also much stricter. The high overall debt levels are due to excessive lending to relatively less profitable SOE’s (30% of which are losing money, compared to only 15% of private firms) and local governments.
  • The government has made financial reforms and heightened access to credit for SME’s one of its main priorities. It has introduced a plan for deposit insurance, which should lessen the financing advantage of the 5 large state banks (which tend to focus too much on large SOE’s), and is considering an increase in the current 75% loans to deposits constraint. Lending and deposit rates have been partially liberalised. Over the next few years, these financial reforms are likely to improve access to loans for the more dynamic private sector and raise the efficiency of China’s economy.

Monetary Policy and Inflation

  • Consumer price inflation in china was 2% in 2014, the lowest since 2009. Year-on-year inflation in December was 1.5%, though part of this represents the effect of lower oil prices instead of lower aggregate demand growth. We expect annual inflation to remain around 2-2.5% in China in 2015-2016, gradually rising towards 3% a year over the rest of the decade. But if oil prices continue close to the recent low level for most of the year, inflation in 2015 could end up declining to 1.7%.
  • The Chinese central bank (the PBOC) responded to the slower growth, lower inflation and higher financial stress in credit markets by cutting its key interest rates in November by 0.25-0.40 percentage points. Our baseline forecast assumes steady PBOC interest rates in 2015, though with a significant likelihood of further interest rate cuts in response to lower economic growth and inflation.

 

Japan

Japan’s economy fell into technical recession in the 3rd quarter of 2014, with GDP declining at an annualised rate of 1.9% (following the 6.9% decline in the 2nd quarter). GDP growth in 2014 is estimated at 0.3%. Despite the announcement in December of a small fiscal stimulus package of 3.5 trillion yen (around $29 billion), a delay in further sales tax increases and lower energy costs, we expect the Japanese economy to grow by 0.3% in 2015, increasing to 1.3% growth in 2016. This is based on our assessment that other factors such as low consumer confidence have contributed to the low growth in 2014 beyond the usual impact of a tax increase, and these factors are likely to persist for a few more quarters. Subsequently, we expect Japan’s economy to grow at an annual rate of around 1% in 2017-2030.

Figure 4: Real GDP Growth in Japan

Real GDP Growth in Japan

Source: Euromonitor International Macro Model

In our most likely downside scenario, greater pessimism could lead to a decline in GDP by 0.5% in 2015, followed by 0.6% growth in 2016. In our most likely upside scenario, lower oil prices and the government’s fiscal stimulus provide a stronger than expected boost to the economy. In this more optimistic scenario, GDP increases by 1.2% in 2015 and 1.9% in 2016.

 

Russia

Our baseline forecast is for Russia’s GDP to contract by 3.8% in 2015 (revised down from a 0.7% expansion in the October forecast) and by a further 0.4% in 2016 (revised down from a  2.2% expansion in the October forecast), with below trend average growth of 1.5% in 2017-2021. But there are large downside risks. If oil prices continue close to their current low levels beyond 2016 and the fears of a banking crisis materialise, the recession could be much worse. In our most likely downside scenario for Russia, the economy would contract by 6.8% in 2015 and by 3.2% in 2016. Our most likely upside scenario would involve a faster rebound in oil prices and lower than expected effects of international sanctions. In this scenario Russia’s economy would still contract by 2.7% in 2015, but it would grow by 0.8% in 2016.

Figure 5: Real GDP Growth in Russia

Real GDP Growth in Russia

Source: Euromonitor International Macro Model 

Several factors have caused the dramatic deterioration of the outlook since October 2014. Sanctions have started to bite, with Russian firms and the government essentially locked out of international financial markets. The government’s foreign reserves have been dwindling. Low oil prices have hurt revenues and could continue for more than a few years. While the Rouble devaluation of almost 50% in the last year softens the decline in oil revenues in local currency, it also leads to large increases in the prices of imports that are critical for the Russian economy and raises the burden of foreign debt. These factors have led to tighter credit conditions and greater private sector pessimism, which lead to even lower growth.

The central bank of Russia has rolled back part of the 6.5 percentage points interest rate increase from December, cutting its key interest rate by 2 percentage point in January. This move may just be enough to stabilise the current recession forecast. The government has also announced a fiscal stimulus package of around 40 billion USD, focused on transfers to banks and large companies. Given the size of the Russian economy, the impact of this package should be modest. We would not expect it to raise GDP by much more than 0.5%.

 

UK

The UK’s GDP growth estimate for 2014 has been revised to 2.5% (down from 3% in our October forecast), in light of the government’s revision of 3rd quarter year-on-year GDP growth to 2.6%, and the preliminary estimate of 0.5% growth in the 4th quarter. Nevertheless, business conditions remain strong with PMI’s well above 50 in recent months. We have maintained our previous forecast for the economy to expand by 2.5% in 2015 and by 2.2% in 2016. Using our most likely downside and upside scenarios gives a range for GDP growth in 2015 of 1.7%-3.3%, and of 1.4%-3% for GDP growth in 2016. Subsequently, GDP is expected to grow at a rate of around 2% in 2017-2030.

Figure 6: Real GDP Growth in the UK

Real GDP Growth in the UK

Source: Euromonitor International Macro Model