6 schroders %, y/y economic and strategy viewpoint · yuan has not devalued further and the bank of...

30 October 2015 For professional investors only

Schroders

Economic and Strategy Viewpoint

Keith Wade Chief Economist and Strategist (44-20)7658 6296

Azad Zangana Senior European Economist and Strategist (44-20)7658 2671

Craig Botham Emerging Markets Economist (44-20)7658 2882

Recession fears haunt the US (page 2)

With the imminent arrival of Halloween, we are focussed on scary scenarios so whilst the likelihood of a China hard landing may have receded, we examine the vulnerability of the US expansion.

The US economy has cooled since the summer and leading indicators suggest growth will slow further. We see the threat to activity as coming more from a retrenchment by the corporate sector where capex is set to be slashed. Inflation horrors are also lurking, but should be kept in check by global spare capacity, reducing the need for the Fed to engage in shock therapy.

UK: Nightmare at no. 11 Downing Street (page 7)

The tax credits horror show highlights the difficulties the government faces in reforming welfare spending. The House of Lords’ shocking blockage of a key financial policy will haunt the Chancellor, sending him back to the drawing board.

However, without welfare reforms, cuts to departmental budgets may have to be even deeper. To add to the Chancellor’s woes, the budget deficit is already off-track, just as the economy is starting to cool. Weaker growth in 2016 could derail the government’s austerity plans.

A very Brazilian house of horrors (page 11)

Despite tentative signs of adjustment, the Brazilian horror story is far from played out. An early exit for a beleaguered president could be the best outcome.

Views at a glance (page 15)

A short summary of our main macro views and where we see the risks to the world economy

Chart: The return of falling goods prices

Source: Thomson Datastream, Schroders Economics Group, 29 October 2015.

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Recession fears haunt the US

Markets rally as policymakers respond and macro fears are not realised

World economy remains vulnerable to shocks as central bank firepower diminishes

“The United States is not at the point of raising rates yet, and under its global responsibilities it can’t raise rates” China’s Finance Minister Lou Jiwei. (Quoted on Reuters 11 October 2015).

Markets have steadied over the past month with the S&P500 beginning to approach previous highs and emerging market equities rallying. The concerns over a hard landing in China, which emerged in the late summer have not been realised and there is a sense that policymakers have become more sensitive to the risks facing the world economy. Three factors support this:

First, the decision by the US Federal Reserve (Fed) not to raise rates in September may have been poorly received initially, but has now helped calm emerging markets where currencies have stabilised. The Fed mentioned global factors in its statement and there is a sense, as illustrated by the quote from Chinese Finance Minister Lou, that it has become the global, rather than just the US, central bank.

Second, we seem to have reached a truce in the currency wars: the Chinese Yuan has not devalued further and the Bank of Japan has resisted pressure for it to increase its quantitative and qualitative easing programme (QQE) and push the Japanese Yen lower.

Finally, recent comments from Mario Draghi at the European Central Bank (ECB), where he opened the door to further quantitative easing (QE), and actual rate cuts by the People’s Bank of China (PBoC) have all improved risk appetite.

The ‘wobbly bike’

Whether this is the result of international co-ordination or a series of independent lucky decisions, central banks have been key to restoring confidence. Continued growth in China, Europe and the US has also helped.

However, the recent growth scare has highlighted the vulnerability of the world economy to a downturn in activity. Leading indicators such as the Conference Board indicator for the US have slowed of late led by a softer S&P500, building permits, manufacturing new orders, and a shorter average work week (chart 1). Growth concerns have been exacerbated by fears that the central banks do not have the firepower to deal with a major adverse shock. Interest rates remain close to zero and although further QE is an option, there are doubts about its efficacy beyond boosting financial market prices and inflaming the debate about inequality.

Chart 1: US leading indicator slows

Source: Thomson Datastream, Schroder Economics Group, 29 October 2015.

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We have reached the stage of the cycle where inflation normally emerges

In this respect investors are still focussed on downside risks and whilst the likelihood of a China hard landing may have receded, there has been increasing concern about a turn in the US cycle. We briefly discussed US recession risks in the July Viewpoint where we also highlighted the vulnerability of the US economy to shocks in the current environment and the slowdown in trend growth. These factors combine to give a ‘wobbly bike’ view of the world economy: slow moving, not very stable and vulnerable to pot holes. Also makes for jittery investors, easily spooked by what can often prove to be noise.

Terrifying triggers for recession

Nonetheless, recessions need a cause and in the current environment, we need to identify what could tip the bike over. Essentially, there are three ways a recession can occur.

The first is as a result of an increase in inflation which prompts the central bank to tighten policy to slow activity and bring inflation under control. There is always talk of engineering a soft landing in such circumstances, but this is rarely achieved and we frequently end up in recession. Sometimes the recession is deliberate such as when inflation is out of control and the tightening cycles of the early 1980s and 90s fall into this category.

Second, a recession can occur as a result of a build up of imbalances. Current account and, or budget deficits build up and there is often talk of a new paradigm where global capital flows can accommodate greater funding gaps until investors begin to question the sustainability of the debt build up and the music stops. The Asia and emerging markets crisis of 1997–98 and the Global Financial crisis (GFC) of 2007–09 are recent examples of this type of recession. Balance sheet recessions tend to be rarer, but deeper than those caused by a pick-up in inflation and monetary tightening.

Finally, there are recessions which originate in the corporate sector through a slowdown in profits, which triggers a retrenchment as firms cut capital expenditure (capex) and jobs. If strong enough, there is then a knock-on effect to consumption. These are less common, but there was a sharp dip in profits ahead of the 2001 recession and profits did fall ahead of the GFC. More often than not though, slower profit growth is a symptom of an economy heading toward recession, rather than the cause.

Today, economists are divided between those who fear inflation and those who are concerned about corporate recession risks. Certainly, we have reached the stage of the cycle where inflation normally emerges and policy is tightened. Chart 2 (next page) shows that unemployment is close to the level seen just prior to the recessions of 2001 and 2007–09. It is below the rate prior to the 1990–91 recession. However, unlike the previous episodes, we have yet to see wages accelerate in a meaningful way. The Employment Cost index (the broadest measure of wage costs) came in at 2.1% year-on-year in Q3, a rate which is unlikely to trouble the Fed.


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Chart 2: Unemployment approaches pre-recession levels

Source: Thomson Datastream, Schroders Economics Group. 30 October 2015.

Low headline consumer price (CPI) inflation may be playing a role in keeping nominal wages subdued at present, but this will reverse in coming months as the depressing effect of lower oil prices drops out of the annual comparison. We would not be surprised to see wages pushing higher in this environment as long as unemployment continues to decline, or remains around current levels.

However, there is a countervailing force on inflation at present as a result of the appreciation of the US dollar and the weakness in emerging markets. Import prices (both with and without oil) are falling and will decline further in coming months as a result of the currency (chart 3). The picture is similar to that seen during the Asia crisis of 1997–98 and whilst the downturn in emerging markets today is not as severe as at that time, we could well move back into a period where the emerging economies weigh on global inflation once more through lower goods prices (see chart front page). Such a development would raise the hurdle for wage inflation to trigger higher rates from the Fed.

Global factors to weigh on inflation

Chart 3: Strong dollar to weigh on inflation


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The other potential cause of recession is more deflationary: a significant corporate sector retrenchment. There are continuing fears over company earnings growth in the US, although yet again the earnings season is showing a high ratio of beats to misses against analysts’ expectations (76% at the last count). At the macro level, profits have slowed after several years of a rise in the profit share of GDP, and in real terms are barely growing. However, they have not turned negative as they did ahead of the last two US recessions (chart 4).

Profits weakness likely to weigh on capex

Chart 4: US profits and real GDP


As with the outlook for inflation, this may change and wages are key. Should we see an acceleration in wages, profits will be squeezed unless firms can maintain pricing power and pass on cost increases (i.e. inflation), or productivity accelerates (i.e. job cuts and layoffs).

On balance we are inclined toward the latter. One indicator that companies are becoming more cautious can be seen in the durable goods orders which are signalling cuts in capital expenditure ahead (chart 5). This does not suggest a corporate sector that is confident about demand and pricing power. Capex and employment often move together so we need to be wary about the effect on the labour market.

Chart 5: Orders signal weaker capex

Source: Thomson Datastream, Schroder Economics Group. 29 October 2015.

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Will this be enough to trigger a recession in the US? Weaker business capex alone is not sufficient and we would need to see the malaise spreading to the consumer through the labour market. Nonetheless, the combination of weaker employment gains and the fading dividend from lower oil prices is likely to moderate consumption in coming months. Meanwhile, on the plus side, housing capex is firm and the drag from inventory is likely to fade.

We will probably trim our US growth forecast for 2016 next month, however, none of the recession drivers have been triggered. The weakness in profits is not acute enough and the pick-up in inflation would need to go beyond base effects to trigger a more aggressive Fed response. We will remain vigilant but at this stage a US recession remains a scary scenario rather than a central view.


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UK: Nightmare at no. 11 Downing Street

Shocking political events in recent days have highlighted the difficulties the government faces in trying to rein in a large structural deficit. To make matters worse, the strong macroeconomic conditions required for the Chancellor to pull-off his magic trick of shifting the burden of the poorly paid back to the private sector is already being questioned. Has George Osborne opened Pandora’s box by trying to reform tax credits? Have the phantom peers gone too far in delaying what is a primary power of the government to enact policy on financial matters?

Trick or treat? Tax credit reforms have few supporters

Near fatal blow dealt by the House of Lords

Trick or treat? The tax credits horror show

The new leader of the main UK opposition party (Labour), Jeremy Corbyn, may have galvanised his party’s membership through his unexpected victory on the back of his more radical socialist views. However, he has failed to make much of an impact in his weekly exchanges with David Cameron at Prime Minister’s Questions. That was until he decided to ask Prime Minister David Cameron the same question six times (out of a possible six opportunities) whether he would guarantee that workers on low incomes would not be worse off once tax credits are reformed as had been announced by the Chancellor of the Exchequer in July. He was essentially asking Cameron whether workers should look forward to a trick or a treat after the range of policy changes are enacted in April 2016. Cameron seemed flustered by the fourth barrage with opposition members of parliament jeering “answer the question!”

“The answer will be set out in the Autumn Statement when we set out our proposals”, replied Cameron – referring to the Chancellor George Osborne’s next economic and fiscal update due on 25 November.

The above exchange took place just two days after the House of Lords (the UK’s unelected upper chamber) decided not to pass a ‘fatal motion’ to kill off Chancellor Osborne’s planned reforms. Instead the Lords voted in favour of blocking the reforms for three years with a demand for an independent review and for the government to consider “possible mitigating actions”. This is the first time in 100 years that the Lords have voted down a financial package backed by members of parliament (MPs) in the House of Commons.

Tax credits were introduced at the start of the previous decade with two key components: child tax credits and working tax credits. Spending on tax credits has risen by £18.6 billion since 2000/01 – an increase of 177%. In 2014/15, tax credits represented 3.9% of all government spending, compared to 2% when first introduced. The government would like to substantially reduce the working tax credits element, but with 55% of funds going to pensioners, it is politically restricted to targeting cuts on workers, with the objective of saving £4.4 billion from the current £29.1 billion bill.

The proposed changes go against the government’s narrative of helping the working poor. Under the previous Conservative-led coalition government, Osborne started to increase the tax-free personal allowance from £6,475 to a planned threshold of £11,000 by 2016/17. This meant that those workers who earn less than the given personal allowance would not pay any income tax (20% at the basic rate).

The government argues that it is trying to remove the tax and spend illusion conjured by the then Chancellor Gordon Brown – a master fiscal wizard. It also argues that the government subsidy for low paid workers is distorting the labour market, and allowing companies to get away with underpaying their staff.

Comparing the impact of the increase in the tax-free personal allowance with the illustrative analysis of the impact of the tax credit changes from the Office for Budgetary Responsibility (OBR), we see that the changes to taxation do not offset the cuts in benefits, especially for those earning less than £10,000 per


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Pain is inevitable, but should be considered alongside other softeners

Deep cuts to departmental budgets may need to be even deeper…

annum (charts 6 and 7). The reforms will reduce the income threshold for tax credits from £6,420 to £3,850, with the tapper rate being raised so that those earning £21,000 and over will stop receiving the credits.

Charts 6 and 7: Slashing tax credits will not be offset by tax cuts alone

Source: OBR, Schroders Economics Group. 28 October 2015.

The government acknowledges this and argues that the tax relief has to be considered with other measures recently announced, such as the introduction of the National Living Wage, and the increased provision of free child care.

Back in the July Budget, Osborne announced what is essentially a rise in the legal minimum wage from the current hourly rate by 7.5% in April 2016, with a view to continue to raise the wage by about 6.2% per annum until 2020. For a person working 35 hours per week, this is will be worth an additional £910 gross per annum from April. But for those that work less hours and are more negatively impacted by the cuts to tax credits, the benefit of the pay increase will be even smaller.

According to the Institute for Fiscal Studies (IFS), the introduction of the National Living Wage “simply cannot provide full compensation for the majority of losses that will be experienced by tax credit recipients – it is just arithmetically impossible”.

1 The House of Commons Library estimated that almost 3.3 million

in-work households receiving tax credits would lose £1,300 from the changes.

Taking all the changes into account including those that began in the last parliament, while there will inevitably be losers, the overall package to low paid workers is broadly balanced. They are designed to incentivise more people to work and to work more hours. The problem with the government’s strategy is that most people have forgotten the tax cuts in past years, and are now only focused on 2016 versus today. It is a strategic error by the Chancellor, one that he will haunt him for some time.

Departmental budget slashing to commence

Putting aside the merits of the tax credits row, the wider implications of the government’s defeat on a key financial policy in the House of Lords raises serious questions over its ability to implement future fiscal reforms. Now that the Lords have tasted blood, will they change their diet? The Conservative party is outnumbered in the upper chamber by Labour party peers and the Liberal Democrats (yes, they continue to haunt the halls of the Palace of Westminster).

1 http://www.ifs.org.uk/uploads/publications/budgets/Budgets%202015/Summer/opening_remarks.pdf

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…then again, the Chancellor could ease up on his fiscal target.

Having had a strong start to the fiscal year, the government has seen public finances lag behind their full-year fiscal target. Public sector net borrowing in the fiscal year to September was 16% lower compared to the previous year, but it means that total borrowing is set to end the fiscal year at around £77.6 billion (4.1% of GDP) – about £8 billion (0.4% of GDP) more than projected by the OBR (chart 8).

Chart 8: Devilish deficit off-track

Source: Thomson Datastream, ONS, Schroders Economics Group. 28 October 2015.

With the government struggling to cut back the welfare bill, it will have to consider deeper cuts in departmental budgets for the upcoming autumn statement which will include a medium-term departmental spending review. With the exceptions of health, overseas aid, defence and schools, central Whitehall departments are being asked to cut their budgets by between 25–40% by 2019–20. Many watchers doubt whether these cuts can realistically be achieved, which is why it is vital the government makes progress reforming welfare spending.

Of course, the Chancellor could make life easier for everyone by scaling back his ambitious austerity plans. Rather than targeting an overall budget surplus, he could target a small deficit, allowing growth to erode public debt. This is general convention for most developed economies. However, with an ageing population becoming ever more expensive, the Chancellor’s more austere targets would create more headroom to deal with the inevitable rise in age-related spending.

Morbid manufacturers endure ghoulish growth

In case Osborne did not have enough to worry about, the latest estimate of the health of the economy will raise more concerns. Quarterly real GDP growth slowed from 0.7% in the second quarter to 0.5% in the third. This is by no means a disaster, but it does suggest that the economy could be heading for a more significant slowdown, just as fiscal tightening begins, and as the Bank of England is considering raising interest rates.

Year-on-year GDP growth has slowed from a peak of 3.1% in the middle of 2014, to 2.3% in the latest quarter. Looking through the sectors, manufacturing stands out as the weakest link, despite the government’s best efforts to provide support for the sector (chart 9 on next page). Manufacturing output contracted for the third consecutive quarter in the third quarter, with annual growth in negative territory. The strength of the pound, especially against the euro, will have been a factor, but the slump cannot really be blamed on external factors, especially as the annual growth rate of goods export volumes in the three months to August is up 8.4% – the fastest rate of growth since April 2011. Spooky!

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Weaker growth could spell trouble in 2016…

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Chart 9: Missing manufacturers?

Source: Thomson Datastream, ONS, Schroders Economics Group. 28 October 2015.

Construction activity has also slowed significantly. This could be an early signal of a slowdown in business investment, which should be expected ahead of the UK’s referendum on its membership of the European Union.

Our baseline forecast assumes that a combination of austerity in 2016 and interest rate hikes will slow GDP growth from 2.5% in 2015 to 2.1% in 2016. However, our forecast for 2015 is likely to be revised down to around 2.4%, while the forecast GDP for 2016 could even be below 2%.

Slower growth in 2016 would not only make austerity less effective, but may also put the government’s plans to introduce the National Living Wage at its current rate, at risk. We could see an increase in unemployment if labour market conditions cannot accommodate the forced increase in wages, which in turn could increase welfare spending. At present, wages are rising of their own accord thanks to strong demand and so a rise in unemployment is not our baseline scenario. However, the risks are significant enough to warrant careful consideration before wages are forced higher.

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A very Brazilian house of horrors

Corruption continues to cripple

Dilma’s position is increasingly untenable

With China hogging the EM limelight in recent months, it has been easy to lose track of developments elsewhere. While next month’s Viewpoint will provide forecast updates on each of the BRICs, with China worries calming now, it seems a good time to review just how bad things have become in Latin America’s biggest economy. President Dilma Rousseff has suffered a series of painful setbacks since her election victory last year, and in many ways is now in political exile despite being nominally in power – approval ratings signal how rapidly the situation has deteriorated (chart 10). The corruption scandal at Petrobras and allegations over accounting irregularities in her campaign and government finances leave the President weakened even as the economy continues its tailspin. The combination of political and economic paralysis has seen a wave of growth and credit downgrades for Brazil, and it is hard to see a rapid turnaround. It could be years before Brazil recovers meaningfully.

Chart 10: Torches and pitchforks

Source: Trusted Sources, CNI/IBOPE. 23 October 2015.

Petrobras scandal lurches on

As we noted in August’s Viewpoint, fall out from the Petrobras scandal (commonly referred to as the Lava Jato, or ‘Car Wash’), has continued to spread, contaminating larger and larger swathes of the corporate and political sectors in Brazil. It has now reached Dilma’s current political nemesis, Eduardo Cunha, Speaker of the Lower House.

Unlike much of the scandal to date, this revelation presents a possible boon to Dilma. Cunha is spearheading attempts to impeach the President, and his removal from office would provide an opportunity for Dilma to rebuild relations with the lower legislature. One tentative olive branch, in the form of a cabinet reshuffle which ceded more political power to the party of Vice President Temer – the PMDB - appears to have backfired by angering other smaller parties in coalition with the PMDB, which were not included in the largesse. They have now splintered from the PMDB, creating a more fractured Lower House which will be even more difficult to reconcile.

The reshuffle, which removed a key ally of the President, also leaves Dilma increasingly isolated within her own government, with former President Lula steadily building control in what some have dubbed a virtual regency (though Lula holds no position of power de jure, he remains influential within the ruling party and popular in Brazil at large). There are concerns that Lula’s next step will be to push for the removal of Finance Minister Levy, who has bought the

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Policy increasingly dictated by anyone but Dilma

Impeachment is a growing risk, but an early exit could help Brazil

government what little fiscal credibility it has. Rumours of his resignation on Friday 16th October prompted downward pressure on Brazilian assets but have since been quashed – likely reflecting assurances from Dilma to Levy that the government would continue to back his fiscal consolidation efforts. This drive by Lula is also likely a result of the Lava Jato scandal, which has begun to implicate family members. Political analysts at Eurasia Group suggest that Lula’s only chance of avoiding prosecution would be if he could portray the investigations as an attempt to undermine the left, and that to do this he needs to reinvigorate his traditional electoral base. Attacking fiscal consolidation is one way to do this.

We mentioned above that the rumours around Levy fuelled volatility in Brazilian assets. More generally, the backdrop for all of this power broking has been an increased likelihood of impeachment for Dilma, forcing the concessions discussed above. This has generated a good deal of volatility across Brazilian markets, with participants seemingly hoping for an impeachment and fresh government (chart 11).

Chart 11: Political risk adds to Brazilian currency volatility

Source: Bloomberg, Schroders Economics Group. 21 October 2015.

Is this justified? Dilma is increasingly powerless and under siege from enemies and allies alike. The corruption scandal is engulfing an ever growing share of the political class and ensuring political energies are focused upon the investigation rather than reform efforts or fiscal consolidation, while those politicians so far untainted are currently deeply unhappy with Dilma – in part because they are being egged on by the Lower House speaker, Cunha. As things stand it is difficult to see how Dilma can lead Brazil out of the mire. Even if Cunha is forced to step down due to the corruption allegations he faces, it is not certain that the new speaker will be any more amenable – there is a strong incentive for the main coalition party, PMDB, to push for impeachment. Vice President Temer, of the PMDB, would then assume the presidency. Though good for the PMDB, this would not necessarily be good for investors, given the exposure of that party to the Lava Jato scandal - so more of the same political paralysis.

What would be a good outcome? One possibility is that Dilma’s re-election is declared void. The country’s highest court has authorised an investigation into the President’s re-election accounts, following revelations that kickbacks from a construction firm were paid into the campaign’s coffers. If compelling evidence is found that serious electoral violations took place and were significant enough to impact the race for the Presidency, the election result could be revoked. Though obviously a disruptive event, this would clear the way for a more market friendly, and scandal free, government to be elected. They would find they had plenty to do.

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High inflation and negative growth persist

Some adjustment is, finally, visible

The undead economy

Activity continues to flatline, with corporate investment moribund in the wake of the Lava Jato scandal, consumers crushed by their debt burdens (chart 12), and government spending squeezed by attempts at fiscal consolidation. Yet despite this, inflation has continued to climb, in hideous parody of a booming economy. The Brazilian zombie economy, lifeless and yet animated, is enough to make policymakers hide behind the sofa.

Chart 12: No signs of life in the real economy


Is there any hope for Brazil? Certainly, the current trend is a negative one, as reflected by the recent S&P and Fitch downgrades, which take the country’s sovereign debt within a whisker of junk status, driven by concern over the fiscal consolidation process. We have written many times, too, on the supply side issues plaguing the economy, contributing to the persistent inflation problem, and the ‘Dutch disease’ inflicted by the multi year commodity boom, which drove up unit labour costs and rendered Brazilian industry uncompetitive.

On the fiscal and supply side concerns, there is little hope for immediate relief. The political situation all but guarantees a lack of productive legislation until a new government comes to power, unencumbered by corruption allegations and infighting. However, market forces are beginning – if only by a war of attrition – to generate an improvement in other metrics. For example, unit labour costs (chart 13) have finally begun to decline as unemployment builds, which ought to lead to an improvement on the trade balance, as seems to be happening (chart 14 on next page).

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Charts 13 & 14: The painful cure for necrosis


All in all, Brazil’s horror story is far from its final act, but perhaps a glimmer of hope is becoming apparent on the very distant horizon. There can though be no painless resolution; perhaps the best case scenario is an early exit for Dilma followed by new elections that allow a purging of the rottenness seemingly embedded at the political core and a new energy with which to pursue reforms.

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Schroder Economics Group: Views at a glance

Macro summary – October 2015

Key points Baseline

After a poor start to the year global growth is now forecast at 2.4% for 2015, slightly lower than 2014. Activity is still expected to pick-up as we move through the year, but parts of the world economy are taking longer than expected to respond to the fall in energy costs.

Despite a weak first quarter, the US economy rebounded in the second and is on a self sustaining path with unemployment set to fall below the NAIRU in 2015, however global pressures are likely to delay Fed tightening until 2016. First rate rise expected in March 2016 with rates rising to 1% by year end.

UK recovery to continue, but to moderate in 2016 with the resumption of austerity. Interest rate normalisation to begin with first rate rise in May 2016 after the trough in CPI inflation. BoE to move cautiously with rates at 1.5% by end 2016 and peaking at around 2.5% in 2017.

Eurozone recovery picks up as fiscal austerity and credit conditions ease whilst lower euro and energy prices support activity. Inflation to remain close to zero throughout 2015, but to turn positive again in 2016. ECB to keep rates on hold and continue sovereign QE through to September 2016.

Despite weak yen, low oil prices and absence of fiscal tightening in 2015, Japanese growth has disappointed. Modest pick-up expected in 2016 as labour market continues to tighten and wages rise, but Abenomics faces considerable challenge over the medium-term to balance recovery with fiscal consolidation. We do not expect the Bank of Japan to increase QQE.

US still leading the cycle, but Japan and Europe begin to close the gap. Dollar to remain firm as the Fed tightens, but to appreciate less than in recent months as loose ECB and BoJ policy is mostly priced in.

Emerging economies benefit from advanced economy upswing, but tighter US monetary policy, a firm dollar and weak commodity prices weigh on growth. Concerns over China’s growth to persist, further fiscal support and easing from the PBoC is likely.

Risks

Risks skewed towards deflation on fears of China hard landing, a bad Grexit and a US recession. The risk that Fed rate hikes lead to a tightening tantrum would also push the world economy in a deflationary direction. Inflationary risks stem from a significant delay to Fed tightening, or a global push toward reflation by policymakers. Although disruptive near term, lower oil prices would boost output and reduce inflation.

Chart: World GDP forecast

Source: Thomson Datastream, Schroders Economics Group. August 2015 forecast. Please note the forecast warning at the back of the document.

4.9

2.52.9

3.6

4.94.5

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Contributions to World GDP growth (y/y), %

US Europe Japan Rest of advanced

BRICS Rest of emerging World

Forecast


16

Schroders Baseline Forecast

Real GDP

y/y% Wt (%) 2014 2015 Prev. Consensus 2016 Prev. Consensus

World 100 2.6 2.4 (2.5) 2.4 2.9 (2.9) 2.8

Advanced* 63.2 1.7 1.8 (1.9) 1.9 2.2 (2.1) 2.1

US 24.5 2.4 2.3 (2.4) 2.5 2.7 (2.5) 2.6

Eurozone 19.2 0.9 1.3 (1.4) 1.5 1.7 (1.6) 1.7

Germany 5.4 1.6 1.3 (1.6) 1.8 2.1 (2.1) 1.9

UK 3.9 3.0 2.5 (2.2) 2.5 2.1 (1.9) 2.4

Japan 7.2 -0.1 0.7 (0.9) 0.6 1.8 (2.0) 1.3

Total Emerging** 36.8 4.3 3.4 (3.6) 3.3 4.1 (4.3) 3.9

BRICs 22.6 5.4 4.1 (4.2) 4.0 4.7 (4.9) 4.7

China 13.5 7.4 6.8 (6.8) 6.8 6.4 (6.5) 6.5

Inflation CPI

y/y% Wt (%) 2014 2015 Prev. Consensus 2016 Prev. Consensus

World 100 2.8 2.9 (2.8) 3.0 3.3 (3.1) 3.6

Advanced* 63.2 1.4 0.5 (0.6) 0.3 1.7 (1.7) 1.4

US 24.5 1.6 0.6 (0.9) 0.2 2.3 (2.3) 1.8

Eurozone 19.2 0.4 0.0 (0.2) 0.1 1.1 (1.2) 1.1

Germany 5.4 0.8 0.2 (0.5) 0.3 1.5 (1.7) 1.4

UK 3.9 1.5 0.0 (0.4) 0.1 1.6 (1.8) 1.4

Japan 7.2 2.7 1.1 (0.8) 0.8 1.1 (1.1) 0.8

Total Emerging** 36.8 5.1 7.0 (6.4) 7.6 6.1 (5.4) 7.3

BRICs 22.6 4.0 4.8 (4.7) 4.7 3.8 (3.6) 3.8

China 13.5 2.0 1.4 (1.4) 1.6 2.0 (2.0) 2.1

Interest rates

% (Month of Dec) Current 2014 2015 Prev. Market 2016 Prev. Market

US*** 0.25 0.25 0.75 (1.00) 0.38 2.00 (2.50) 0.86

UK 0.50 0.50 0.50 (0.50) 0.59 1.50 (1.50) 0.86

Eurozone 0.05 0.05 0.05 (0.05) -0.12 0.05 (0.05) -0.17

Japan 0.10 0.10 0.10 (0.10) 0.18 0.10 (0.10) 0.16

China 4.35 5.60 4.60 (4.60) - 4.00 (4.00) -

Other monetary policy

(Over year or by Dec) Current 2014 2015 Prev. 2016 Prev.

US QE ($Bn) 4495 4498 4504 (4494) 4522 (4512)

EZ QE (€Bn) 103 31 649 (649) 1189 (1189)

UK QE (£Bn) 375 375 375 (375) 375 (375)

JP QE (¥Tn) 345 300 389 (389) 406 (406)

China RRR (%) 18.00 20.00 17.50 18.00 16.00 17.00

Key variables

FX (Month of Dec) Current 2014 2015 Prev. Y/Y(%) 2016 Prev. Y/Y(%)

USD/GBP 1.53 1.56 1.53 (1.52) -1.9 1.50 (1.50) -2.0

USD/EUR 1.11 1.21 1.08 (1.08) -10.7 1.02 (1.00) -5.6

JPY/USD 120.6 119.9 120.0 (118) 0.1 120.0 (115) 0.0

GBP/EUR 0.72 0.78 0.71 (0.71) -9.0 0.68 (0.67) -3.7

RMB/USD 6.36 6.20 6.30 (6.30) 1.5 6.40 (6.40) 1.6

Commodities (over year)

Brent Crude 48.3 55.8 55.0 (64) -1.6 55.5 (71) 0.9

Consensus inflation numbers for Emerging Markets is for end of period, and is not directly comparable.

Previous forecast refers to May 2015

Croatia, Latvia, Lithuania.

*** The forecast for US policy interest rates w as updated this month, w ith the previous forecast refering to the August update.

Source: Schroders, Thomson Datastream, Consensus Economics, October 2015

Market data as at 28/10/2015

* Advanced markets: Australia, Canada, Denmark, Euro area, Israel, Japan, New Zealand, Singapore, Sw eden, Sw itzerland,

Sw eden, Sw itzerland, United Kingdom, United States.

** Emerging markets : Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela, China, India, Indonesia, Malaysia, Philippines,

South Korea, Taiw an, Thailand, South Africa, Russia, Czech Rep., Hungary, Poland, Romania, Turkey, Ukraine, Bulgaria,


17

Updated forecast charts – Consensus Economics

For the EM, EM Asia and Pacific ex Japan, growth and inflation forecasts are GDP weighted and calculated using Consensus Economics forecasts of individual countries.

Chart A: GDP consensus forecasts

2015 2016

2015 2016

Source: Consensus Economics (October 2015), Schroders

Pacific ex. Japan: Australia, Hong Kong, New Zealand, Singapore

Emerging Asia: China, India, Indonesia, Malaysia, Philippines, South Korea, Taiwan, Thailand

Emerging markets: China, India, Indonesia, Malaysia, Philippines, South Korea, Taiwan, Thailand, Argentina, Brazil, Colombia, Chile, Mexico, Peru, Venezuela, South Africa, Czech Republic, Hungary, Poland, Romania, Russia, Turkey, Ukraine, Bulgaria, Croatia, Estonia, Latvia, Lithuania

The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own

assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to

our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors. The views and opinions contained herein

are those of Schroder Investments Management’s Economics team, and may not necessarily represent views expressed or reflected in other Schroders

communications, strategies or funds. This document does not constitute an offer to sell or any solicitation of any offer to buy securities or any other instrument

described in this document. The information and opinions contained in this document have been obtained from sources we consider to be reliable. No

responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the

Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed

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Chart B: Inflation consensus forecasts

6 schroders %, y/y economic and strategy viewpoint · yuan has not devalued further and the bank of...

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