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The Macro View: Growth may prove fleeting

In the long term, the global economy faces major obstacles to a sustainable recovery. Most worryingly, escalating sovereign debt is not simply a localised problem restricted to weak economies such as Greece, but a major global issue that threatens to push the world economy into stagnation or decline.

Economic growth, albeit fragile, is now firmly under way in most economies and the pace of expansion is likely to strengthen in the next two to three quarters. Almost all the GDP growth forecasts for 2010 are now higher than a month ago. But stronger short-term activity is unlikely to last. Growth forecasts for 2011 have mostly been revised down. These modest changes in expectations should not be overstated. Their message is clear: earlier hopes of growth strengthening over the medium term are questionable.

There is a serious risk that the global recovery may falter once the forces underpinning it come to an end. Changes in the inventories cycle, as we move from destocking to restocking, can only be temporary. The huge monetary and fiscal stimulus, introduced to ensure that a nasty recession does not degenerate into depression, will inevitably have to be withdrawn over the next 12 to 18 months. But, there are important differences between emerging and developed economies.

Ones to watch
In India and China, growth is very strong and inflation is rising. Policymakers are acting to counter bubbles. Chinese consumer prices rose 2.7 percent in the year to February, the highest rate for 16 months. Price increases are sharper than expected and the pace is accelerating. Measures have already been taken to contain Chinese lending growth, particularly to the property sector, and more will follow.

In India, some measures of inflation are above 10 percent and the Reserve Bank of India has announced a surprising increase in interest rates recently. It is clear that both China and India will tighten policy further in the near future; given their growing weight, this may have wider repercussions, reinforcing concerns that global growth may slow in 2011. Even so, China and India remain the fastest growing economies.

Among the developed economies, inflationary pressures in the US and Europe are still weak. Threats to growth are serious. Though the central banks are uncomfortable with the scale of the current stimulus, they know that tightening too early or too abruptly could unleash a double-dip recession. Given this background, the US Federal Reserve and the European Central Bank (ECB) are withdrawing only slowly some of the secondary support that they have provided to various credit markets. But there will be no major tightening, and no near-term increases in the key policy interest rates. The Fed funds rate at 0 to 0.25 percent, and the main ECB rate at 1 percent, are both set to stay at very low levels until the final months of this year at the earliest. I also expect the Bank of England to keep Bank Rate at 0.5 percent until the fourth quarter of 2010.

Ahead of Europe
The relatively strong pace of recovery in the US is reinforcing short-term optimism. At an annualised rate of 5.6 percent, US GDP growth in the fourth quarter of 2009 was the best performance in six years. More significantly, the news that 162,000 new US jobs were created in March 2010 has eased fears that the US is facing a jobless recovery. The US recovery is not yet secure, but is much stronger than in Europe. In the fourth quarter of 2009, eurozone GDP expanded by a negligible 0.1 percent and UK GDP rose by 0.4 percent.

Europe’s leaders have patched together an agreement to support Greece and help it avoid default. But Germany insisted on very tough terms and it remains to be seen if weaker eurozone members can live with these conditions. By avoiding a full-blown crisis, the Greek package provides short-term relief. But the interest rate premium that Greece must pay to secure credit remains very high, and the euro remains under pressure.

As financial markets become increasingly dominated by sovereign risk concerns, the US dollar will benefit in the short term from the consequences of the Greek crisis and the perception that US growth prospects remain distinctly better than in Europe and Japan.

But surging sovereign debt is rapidly emerging as a major factor that could reduce growth prospects for many economies, including the US. If major debt crises trigger defaults we could face a new major world recession. To defend its position, the US will have to manage its relationships with emerging Asian giants, notably China, wisely.

David Kern is chief economist at the British Chambers of Commerce

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