Five issues that will make – or break – the world economy in 2015
Next
year will bring either vigorous recovery or a return to global
recession. We look at the factors that will affect the outcome of a
pivotal 12 months
The world economy enters 2015 at a fork in the road. One
track leads to the self-sustaining vigorous recovery that policy makers
have sought in vain ever since the financial crisis erupted in 2007.
Lower oil prices get consumers spending and businesses investing.
Memories of the biggest recession since the 1930s are finally banished.
The rest of the world starts to look like a revitalised US.
The other track leads back towards recession. Problems that
have been stored up since 2008-09 can be contained no longer. A
financial crisis erupts in the emerging markets. China has a hard
landing. Greece sparks off a fresh phase to the eurozone’s struggle for
survival. Deflation sets in. The rest of the world starts to look like
Japan. Here, then, are five issues that will define a make-or-break
year.
Russia and the Ukraine
The Russian economy will go into deep freeze in 2015. Even
before the dramatic plunge in the rouble in the weeks running up to
Christmas, the central bank was predicting a fall in output of 4.5%.
Pushing up interest rates from 10.5% to 17% in one move may well help to
stabilise the rouble and prevent further capital flight – but at a
cost. Neil Shearing of Capital Economics says history is about to repeat
itself; just as after the debt default of 1998, Russia is “staring down
the barrel of a deep recession”. The depth of that slump, Shearing
says, will depend on what happens to the price of oil and whether the
west lifts the economic sanctions that it has gradually been
intensifying since last spring.
Two other things are also unclear. Firstly, how Vladimir
Putin will respond. The Russian president offered the people a bargain:
accept a hard man in the Kremlin in return for rising living standards.
That deal will be broken in 2015, and there is no guarantee that it will
encourage the Kremlin to take a softer line over Ukraine. On the
contrary, a failing economy could spur Putin into acts of nationalist
defiance. That would not just intensify the recession; it would also
have knock-on effects for Russia’s neighbours and for the eurozone.
The second unknown is whether Russia will be a special case.
The fear is that it will set off a chain reaction across other emerging
markets that have attracted the copious amounts of footloose capital
generated by the quantitative-easing (money-creation) programmes of the
world’s central banks. Turkey and Indonesia and are two big countries to
look out for.
Oil
In the summer of 2014, a barrel of Brent crude was changing
hands at $115 a barrel. By Christmas it could be obtained for barely
half that price. The big drop in the oil price is positive for global
growth: it puts more spending power in the hands of consumers and it
cuts costs for businesses. The link between the cost of crude and the
world economy is well established: the long booms of 1948-1973 and the
15-year period that preceded the great recession of 2008-09 were both
built on cheap oil. The four recessions of the postwar era (1974-75,
1981-82, 1990-91 and 2008-09) have all been associated with rising oil
prices. Trevor Greetham, director of asset allocation at Fidelity
Solutions, says: “A low oil price is a stimulus for consumers. Global
growth should pick up over 2015 and there are as yet few signs of the
kind of inflation that would necessitate meaningful monetary
tightening.”
But there is a caveat. Greetham says the plunging oil price
could prompt “credit stress”. This would affect governments, such as
Russia, Venezuela and Iran, that can only balance their books if the oil
price is at $100 a barrel or more. And it would affect the shale gas
sector in the US, where much of the investment has been financed by
high-yielding but risky junk bonds. As the Bank of England points out in
its recent Financial Stability Review: “As US oil and gas
exploration firms account for 13% of outstanding debt in US high-yield
bond markets, an increase in the preceived or realised credit risk in
this sector could lead to sales by investors and potentially illiquidity
in the broader high-yield market”. In other words, shale could be the
next sub-prime.
China
China will be crucial to the performance of the global
economy in 2015. Depending on the yardstick used, it is now the world’s
biggest economy. It is also, according to Kenneth Culkier of the Economist magazine,
a net exporter of foreign direct investment. China could soon join the
select club of countries with a reserve currency.
But 2014 has been an uneasy year, as Beijing has tried to
mop up the credit excesses left behind after the growth-at-all-costs
approach adopted during the deep downturn of late 2008. Policy makers
have been running a tight ship and the constraints on credit have
started to bite. Growth will be lower in 2015: the question is how much
lower.
A marked slowdown would affect the rest of the world in two
big ways. First, exports to China would weaken. This would affect
countries such as Germany, which sell the machine tools needed for
China’s industrial expansion, and those, such as Australia, that provide
China with its raw materials. A sluggish Chinese economy in 2015 will
compound a low oil price.
Second, China will export deflation to the rest of the
world. The prices of goods leaving China are already falling and that
trend will continue. The US and Europe will be flooded with cheap
Chinese goods, driving down inflation. In the case of the eurozone, it
may result in deflation. Central banks, faced with inflation being well
below target, will be cautious about raising interest rates even if
their economies are growing at a healthy rate, risking the recreation of
the conditions that led to the pre-2007 asset bubbles.
US
Next year will be hugely significant for Janet Yellen and
her colleagues at the Federal Reserve, and for global markets. A focus
for investors in the new year will be the timing of the first rise in
interest rates. Rates have been in a record low range of between zero
and 0.25% since December 2008, but the economy has been gaining momentum
in recent months. The Fed has already called time on its $4.5tn
bond-buying programme, completing its final purchases in October.
Winding the clock back to May 2013, then chairman Ben Bernanke triggered
a so-called “taper tantrum” when he suggested the Fed might start
slowing the rate of its bond-buying sooner than markets were expecting.
Investors – hooked on ultra-loose monetary policy since the crisis fully
erupted in 2008 – took fright and triggered a fresh wave of volatility.
Given we’re talking about the world’s largest economy,
speculation on the first rate rise will have repercussions around the
world. Investors will scrutinise Fed statements for any change in tone
that might indicate when the first increase will come. Until it does
come, uncertainty – despised by markets – will reign. At its latest
policy meeting in December, the Fed dropped its insistence that rates
would be kept on hold for a “considerable period”, replacing it with the
message that it could be “patient” about policy changes. Within minutes
of the statement, New York’s Dow Jones Industrial Average shot up 1.5%,
as investors interpreted it as a signal that there would be no mad rush
to raise rates. However, if the economic data in the coming weeks and
months continues to reflect a strengthening US economy, the Fed’s
patience may wear thin. Expect market volatility when the central bank
drops its cautious tone as it paves the way for the first rate rise
since the great recession.
Eurozone
The eurozone is the crisis that keeps on giving, and there
is every reason to believe this will remain the case in 2015. Mario
Draghi, the eloquent president of the European Central Bank, lifted the
single currency bloc out of the worst phase of the crisis in the summer
of 2012 simply by saying that he would do “whatever it takes” to save
the euro. But he now faces one of his biggest challenges yet.
In 2014, the story in the eurozone was one of a recovery
that failed to get off the ground and of the mounting threat of
deflation. Neither of those problems has gone away, with growth of just
0.2% in the third quarter of 2014 and an annual inflation rate of 0.3%
at last count in November. Greece and Spain are already stuck in a
deflationary rut and there is concern that a dangerous deflationary
spiral will spread to the rest of the region. The fear is that as prices
continue to fall, businesses and consumers will delay spending plans as
they expect prices to fall further. With a backdrop of weak growth, low
oil prices and general lack of inflationary pressures, the ECB’s battle
against deflation will continue well into 2015.
Measures announced in 2014 – including charging banks to
park cash with the central bank in a bid to encourage more lending –
have failed to provide a silver bullet. The bank has one weapon left up
its sleeve: full-blown quantitative easing.
So far the eurozone’s policymakers have failed to take the
plunge with QE, largely as a result of forceful opposition from Germany.
But 2015 could be the year to abandon the hints and throw the kitchen
sink at the problem. More weak data from the eurozone will make
investors nervy. Failure to press the QE button in the face of weakness
could trigger outright panic.
The relevance for the UK is huge: policymakers at the Bank
of England and within government have repeatedly warned that fragility
in the eurozone is one of the biggest threats to the UK recovery, not
least because it is Britain’s biggest trading partner.
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