As another tumultuous year draws to a close, the markets will be hoping for a better economy in 2012. Unfortunately, the omens do not look encouraging. Many of the problems that have undermined growth have still to be resolved; public and private sector debt remains high; the process of deleveraging continues apace; while the world's major internal and external imbalances remain a substantial threat to economic stability.
Economists are often accused of stressing the uncertainties that surround their forecasts, although there can be little doubt that the global economy has been beset over the past year by a large number of so-called 'economic shocks'. Not only has the euro crisis taken one severe turn after another, but the global economy has also had to deal with the fallout of the Japanese earthquake/tsunami, various floods, the Arab Spring and the impact of the surge in energy prices.
Faced with these 'shocks' 2011 has been another year when economists have general ly overpredicted growth and under-predicted inflation. At the start of the year, the consensus was that the global economy would expand by around 3.5% in 2011, with global inflation holding around 2.8%. With the year almost complete, these outturns looks set to come in at 2.9% and 3.7%, respectively. For 2012, the consensus for GDP growth has also been steadily lowered, from 3.6% in February to 2.7% currently (Chart 1).
As we head into next year, the crisis in the euro area continues to hang over the region's (and global) prospects like the sword of Damocles. Given the turmoil in Europe we have recently revised down our forecast for UK GDP growth in 2012 from 1.5% to just 0.5%, with the UK expected to move into a recession in the next six months. Thereafter, we forecast a modest recovery, aided by a fal l in inflation and further, potential ly aggressive, monetary stimulus. Against the backdrop of ongoing deleveraging, however, the recovery is likely to be a protracted one.
It is not only in Europe where significant sources of uncertainty reside. 2012 looks set to be another year when politics and economics collide. Twenty-four countries worldwide will appoint new political leaders or reappoint existing ones - including the four major economic powers, China, Russia, France and the US. Furthermore, an early election in the UK cannot be ruled out if splits in the coalition over Europe continue to widen.
The change in China's 10-year leadership in October will be watched particularly closely to see whether it helps foster the much-needed economic rebalancing between East and West. US presidential elections in November will also be pivotal, as markets size up the prospect of substantial US fiscal restraint from 2013.
It is the euro crisis, however, that is set to dominate. Ongoing discussions over EU treaty changes raise scope for big euro event risk across the region, while French elections (April) will almost certainly be viewed as a referendum on the nature of euro membership. Our base case is that the euro area falls into recession in 2012, but that a collapse of the single currency is averted. We concede, however, that the risk of a more severe outcome for the euro area and, as a consequence, the UK are high (Chart 2).
Given the scale of the challenges, that the world economy is expected to grow at all in 2012 is testament to its resilience. Although Europe looks almost certain to be a weak spot, the US is showing encouraging signs of life, aided by signs of stability in the housing market. The developing economies, too, should hold up reasonably well, supported by renewed policy stimulus.
In the absence of a melt-down in Europe, we are cautiously optimistic that the world economy will avoid a 2008/09-style downturn in 2012. But there can be little doubt that the challenges and uncertainties remain substantial. That the coming year looks almost certain to be another highly uncertain one is perhaps our safest call of all.
UK DATA PREVIEW
Manufacturing PMI (Dec)Signs of slowing economic activity have been evident in the monthly PMIs. The manufacturing PMI has fallen consecutively over the past four months to stand at 47.6 currently. The rapid fall in the new orders component, and the CBI industrial trends survey plummeting to a twoyear low in December point to a further decline in the index. The new orders component has contracted for seven consecutive months, driven in part by a sharp fall in the new export orders index to a sub-50 level. As a result, we forecast a further drop to 47.0 in December. This would suggest a contraction in manufacturing output in Q4, while we expect overall GDP to be flat. Looking ahead, prospects for manufacturing sentiment hang largely on an improvement in euro area economic confidence.
Services PMI (Dec)
The broad impact of the euro area turmoil will be felt through the service sector. We expect the worsening sentiment in the manufacturing PMI to be echoed in the services PMI. The sharp decline in the new business orders component, combined with an acceleration in the decline of outstanding business orders, raise concerns over the outlook for service sector activity. As such, we forecast the index dropping back in December to 51.2 from 52.1 in November. This is consistent with the economy close to stalling and adds to the case for further monetary stimulus. We expect the services PMI to remain subdued over coming months, paving the way for the Bank of England to announce additional Quantitative Easing early in 2012.
Our own Business Barometer provides some of the most forward-looking information on the economy. The economic prospects index compares current sentiment on the general economic situation with that of three months ago. Since reaching a recent high of +36 in June, the balance has fallen back sharply in recent months, to currently stand at -20, the lowest since January 2009. The pace of the deterioration in the index has been more rapid than the PMIs suggest and as such implies a much weaker outlook for the economy. The survey suggests that growth is likely to have stagnated in Q4, with a material risk of output contracting in Q1. The survey currently attaches a 44% probability of the UK economy dipping back into recession in the first half of 2012.
In contrast to the significant deterioration in consumer confidence, activity in the housing market has steadily improved over recent months. In October mortgage approvals hit a 22-month high of 52.7k. We look for a further modest improvement to 53.0k in November. This would mark the highest level since end-2009. However, activity at current levels still remains well below the precrisis 10yr average of around 100k each month. Looking ahead, it is doubtful these improvements can be sustained. Indeed, faced with the prospect of rising unemployment, weak economic activity and wholesale funding pressures, mortgage approvals could slip back again in 2012.
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