We have lowered our forecast for global growth in 2012 from 3.2 per cent to 2.8 per cent.
That compares with the Government's forecast of 3.5 per cent and the next IMF forecast which we expect to be 3.25 per cent.
The main sources of our downward revisions to growth in 2012 are: China (8.1 per cent to 7.5 per cent); Europe (-0.6 per cent to -1 per cent); India (7 per cent to 6 per cent); Japan (3.2 per cent to 2 per cent) and general downward revisions to other Asian and emerging market economies to reflect the impact of the weaker outlook for the majors.
The 0.4 percentage point downward revision is explained by China (0.1 percentage points); India (0.1 percentage points); Europe (0.05 percentage points); Japan (0.05 percentage points) and "other” (0.1 percentage points).
The broad themes relate to: China’s difficulties with managing a smooth domestic slowdown in the first half of the year in the face of weak export growth; India’s investment-led growth model exhibiting vulnerability to a tightening in global credit availability; Japan’s recovery from disaster being stunted by weak demand for its exports and the strong yen; and further deterioration in the outlook for Europe, with spillover effects for the rest of the globe, with particular reference to East Asia’s manufacturing exporters.
We have held our Australian dollar forecast for a fall to 93 US cents by mid-year for some months, but this even weaker global outlook implies definite downside risks for the Australian dollar outlook.
We still see that lowpoint around mid-year, by which time policy easing, particularly in China, will be gaining some traction. Of course the recent fall in inflation and the first move by the Chinese authorities to ease reserve ratios for Chinese banks signal the turning point in policy with the authorities gradually adopting an easing stance.
We expect that the weakest data prints for China will be in the first half of 2012 while the authorities take time to implement more stimulus. That perception will certainly represent some downward pressure on the Australian dollar.
For Europe, we continue to question whether a currency union can exist without fiscal union.
Delays in the adoption of an effective fiscal union are likely to be driven by a reluctance of the distressed members to subjugate sovereignty; and the reluctance of the stable nations to sign up for the necessary fiscal transfers. However our forecasts are built around the eventual adoption of some form of quantitative easing by the European Central Bank which would "buy” considerable time to allow resolution of the necessary fiscal arrangements.
Without a significant role for the ECB, we would be forced to adopt an even bleaker growth outlook.
Our expectation that the Australian dollar will be back around parity by end 2012 hinges on the success of policy easing in China and a successful intervention from the ECB.
Such policy stimulus has already been exhausted in the US. We continue to expect a form of QE3 in the US in 2012 but its effect will be nowhere near as critical for growth stability as QE1 will be in Europe.
The importance of quantitative easing policies in Europe and the US is emphasised by the likely tightening of fiscal policy in both regions. Austerity measures, which some have estimated might take up to 1 percentage point from European growth, will need to be offset by an aggressive QE approach.
Delays in extending payroll cuts and unemployment benefits in the US represent a further possible fiscal tightening in the US which, if common sense does not prevail at Congress, will certainly require another round of QE to act as an offset.
There is considerable criticism of QE1 in Europe. The Germans are concerned about a build up in the monetary base which could establish the foundations for an inflation problem. However we expect that by March it will become apparent that due to a widening of the output gap inflation risks are minimal.
There is the associated argument of transferring an obligation of public finance into a monetary phenomenon. It is also argued that the prohibition of monetary financing is an indispensable element of a stable currency. This fundamental principle of the European Monetary Union is written into the Maastricht Treaty so it is likely that adjustments to the Treaty will be required.
Consequently, our current timetable of an adoption of some form of QE by March may be optimistic. I must emphasise that our European forecasts are dependent upon this expanded role for the ECB.
Around €200 billion of redemptions of Italian/Spanish/French sovereigns over the January-February period of 2012 are likely to highlight the clear need for ECB support for the markets. Further, we expect that the slowdown in the economy which is now underway will make the widening of the output gap sufficiently clear to allay any concerns with inflation in Europe.
Next year is likely to be a year when those countries which have the flexibility to ease policy will take it. For us that means lower rates in Australia; QE in both US and Europe; and general easing of policy in China and other developing economies.
Shaping our view on the domestic economic outlook are key positives which set Australia apart from most other advanced economies. Notably, the mining investment boom gathered momentum during 2011 and is set to continue. Policy flexibility is another factor, as evidence from the RBA commencing an interest rate easing cycle. The floating exchange rate is also a plus.
As discussed, we expect the currency to continue playing its shock absorber role. This easing of overall monetary conditions will provide a boost to conditions in the broader economy. This should see a more even economic expansion emerge during 2012 such that overall growth improves from a 2.25 per cent annualised pace over the first half of the year to a 3.5 per cent pace over the second half of 2012.
These positives for Australia are balanced against weakening word growth, as well as a number of domestic constraints. The domestic economy faces headwinds: interest rates, the high dollar, stretched housing affordability, household debt and fiscal consolidation.
Together, these factors suggest the consumer, housing construction and public investment will restrain growth. In short, the risk is that growth will persist at a sub-trend pace for a little longer. Given this, we’ve lowered forecast growth for the year to December 2012 to 3 per cent from 3.5 per cent.
In particular, prospects for housing construction, near term, and net exports are less favourable than expected. From the perspective of monetary policy we continue to stick with our forecast that the RBA will cut rates by a total of 100bps in this cycle. Consequently, there are 50bps of further easing to come.
With the current developments in the domestic labour market and ongoing uncertainty globally we expect that the next rate cut of 25bps will come in February.
Bill Evans is Westpac’s chief economist.