Our bear case is a full-blown recession, and it won't take much to tip the balance. Our base case assumes that European governments make a big step towards fiscal integration soon that stabilises confidence, and that US Congress extends most of this year's stimulus. Against the backdrop of recent policy mistakes, these assumptions may seem heroic. Failure on these fronts would risk a full-blown recession in the US and Europe, with global GDP growth falling below the 2.5% recession threshold.
Fiscal dominance and monetary easing: Central banks in much of the developed world now operate under a new regime of fiscal dominance, in which monetary policy is dominated by governments' inability to stabilise the debt or even fund themselves at reasonable interest rates. In such a regime, inflation targeting becomes irrelevant because debt concerns take the upper hand. It also means that central bank independence has been just a historical episode: Central banks will be forced to solve the problem of unsustainable public debt by pushing real interest rates as far as possible into negative territory through conventional and unconventional ways of reducing nominal interest rates across the yield curve, and through engineering inflation. While we see further monetary easing in the base case from the Fed, ECB and the Bank of England, we do not expect EMs (specifically China) to be the knights in shining armour, as they were in 2009, when they eased monetary and fiscal policy to historical levels. Having said that, to the extent that DM policy help isn't immediate or aggressive, we believe that EM policy-makers are better off buying insurance via pre-emptive easing.
In the pieces that follow, our global economics team presents its views on how each region will fare in the coming year as the world continues to recover (please note that most of these essays were published at the end of November). This is the final edition of the Global Economic Forum for 2011. We will resume regular publication beginning in the first week of 2012.
Cutting forecasts again: When we slashed our global growth forecasts back in August (see Global Economics: Dangerously Close to Recession, August 17, 2011), many called us alarmist. However, consensus growth expectations have followed us down and recession fears have been on the up. Rightly so, as in our view Europe has now entered another recession, only a little more than two years after the last recession ended - we cut our 2012 GDP forecast for the euro area from 0.5% to -0.2%. Our US base case remains anaemic growth of just over 2% next year, but this crucially depends on our assumption that Congress will extend most of this year's fiscal stimulus into next year - expiration could easily tip the US into a double-dip. Unsurprisingly against this backdrop, growth prospects for emerging market economies have dimmed further - we cut our forecast for the EM universe from 6.1% to 5.7%, with China 2012 GDP going from 8.7% to 8.4%. Overall, this takes our PPP-weighted (and thus EM-heavy) 2012 global GDP forecast down from 3.8% to 3.5% and thus below the long-term average.
BBB to CCC: How could the world economy end up here? For starters, the recovery that followed the Great Recession was always going to be bumpy, below-par and brittle - one of our key themes since 2009. This is what recoveries following a credit boom-to-bust cycle usually look like, and the credit boom and bust of the last decade had epic proportions, leaving a large, looming legacy for the recovery. Since then, deleveraging and a destruction of potential output in the former boom sectors and economies has been the name of the game. To prop up growth, governments had to expand their balance sheets (which is now backfiring, especially in Europe), and central banks had to engage in unprecedented conventional and unconventional easing. Yet, what worked in 2009 and 2010 became more difficult in 2011, especially since the summer, when the BBB recovery morphed into a CCC crisis - a crisis of confidence, competency and credibility. As we already laid out in our August forecast revision, policy errors on both sides of the Atlantic - the debt ceiling debate in the US and the decision to haircut private holders of Greek debt in Europe - led to a rapid loss of confidence in governments' ability to contain the fiscal crisis. The CCC crisis shook financial markets and led to a plunge in consumer and business confidence, which is now increasingly showing up in the hard data on demand and output around the globe.
Policy procrastination: Policy-makers have not appeared to help matters since the summer. Last week, the US Congress Super Committee, which was created and mandated after the debt ceiling debacle to come up with a plan to cut the US deficit by US$1.2 trillion over the next decade, declared its failure. In Europe, even more ominously, euro area governments in late October put all their hopes on a plan to leverage up the EFSF rescue fund, which has faltered since. In addition, their decision to give banks until June 2012 to raise their core Tier 1 capital ratios to 9% has sparked a huge wave of bank deleveraging which should negatively affect growth both inside and outside the euro area.
Our base case: no further mistakes: Against this backdrop, the policy assumptions underlying our base case forecasts for 2012 may seem heroic. In the US, we assume that following the Super Committee's failure, in the next four weeks, Congress will extend the payroll tax cuts and the extended unemployment benefits for another year. In Europe, we assume that governments will take a significant step towards fiscal integration in December that helps to stabilise confidence and allows the ECB to step up its support for broken bond markets. While this would not prevent a recession - we think it is too late - it could keep it relatively shallow. Given that these upcoming decisions in the US and Europe are on a knife-edge, our base case could easily turn out to be too optimistic and be replaced by a darker scenario - our bear case.
Our bear case: full-blown global recession: To model such a global bear case, we assume that, contrary to our base case assumptions, US Congress fails to extend the payroll tax cut and the extended unemployment benefits into 2012, which would result in a fiscal tightening of a little more than 1% of GDP. In Europe, our bear case assumes governments do not come up with a convincing fiscal solution on December 9 and bond yields in response push higher still. These policy mistakes depress confidence and domestic demand further. Transmission to the rest of the world follows through the asset price channel, through further bank deleveraging, and the trade channel - we assume a halving of world trade growth compared to the baseline. As a consequence, global growth plunges to 1.9% in 2012 and thus below the recession threshold of 2.5%. The US economy contracts for most of 2012, Europe through all of the year. China's GDP growth slows to 7.7%, with rapid fiscal easing preventing a worse outcome.
Super-bear case: you don't really want to know: So, depending on the policy decision taken or not taken over the next month, our bear case for the global economy may soon become the base case. In fact, even our bear case may still be too optimistic. If European governments fail to agree on a big step towards fiscal integration on December 9, and if the ECB refuses to step up support, a super-bear scenario including serial private and public sector defaults and euro break-up may well materialise. To be sure, we still view this as a tail event, even though the tail has become fatter recently. Putting numbers for GDP and other economic indicators to such a scenario is extremely difficult. Yet, the Great Recession that followed the Lehman bankruptcy would probably pale in comparison to a scenario involving a euro break-up and widespread bank and government failures.
We also construct a ‘reasonable' bull case, which assumes a swift and convincing solution of Europe's sovereign crisis and a balanced US medium-term deficit-reduction plan combined with extension of fiscal stimulus into next year. Confidence and domestic demand would pick up and world trade would grow by 2 percentage points more than in the base case. In this scenario, global GDP expands by 4.2% in 2012, against 3.5% in the base case and 1.9% in the bear case.
More monetary easing: But back to our current base case - how will monetary policy react to sluggish and fragile growth in the US and the unfolding recession in Europe? In the US, our team now expects the Fed to embark on a third round of quantitative easing, probably aimed mainly at the mortgage market, next spring. In Europe, our team now sees the ECB cutting the refi rate by an additional 75bp to 0.5% (25bp of this came on December 8). Further term funding support for banks at longer than one-year maturities also appears to be on the cards. In addition, the ECB may decide to embark on large-scale government bond purchases spread across all euro area government bond markets in order to minimise looming downside risks to price stability and ensure the transmission of its low interest rate policy to member state economies. And in the UK, the MPC is likely to increase gilt purchases by another £75 billion starting in February.
Fiscal dominance: Taking a step back from the near-term policy outlook, it is important to note that central banks in much of the developed world now operate under a new regime - fiscal dominance (see The Global Monetary Analyst: Is Modern Central Banking Ancient History? October 19, 2011). This means that monetary policy is dominated by governments' inability to stabilise the debt or even fund themselves at reasonable interest rates. In this regime, inflation targeting and Taylor rules - which l postulate that central banks adjust interest rates to stabilise economic fluctuations and minimise deviations of inflation from target - become irrelevant because debt concerns take the upper hand. It also means that central bank independence has been just a historical episode. Central banks were made independent to help them fight what was perceived to be the biggest macroeconomic problem two or three decades ago - inflation. That was then. Today, the biggest macroeconomic problem is unsustainable public debt, and central banks will, whether they like it or not, be forced to help solve this problem. How? By pushing real interest rates as far as possible into negative territory through conventional and unconventional ways of reducing nominal interest rates across the yield curve, and through engineering inflation. They may still pay lip service to inflation targeting, but the new approach seems to be: if inflation shows up, first try to define it away by looking at some concept of core inflation that is lower. And if you cannot define it away, forecast it away - produce a forecast showing inflation back at or below target in 1-2 years' time and keep short rates near zero and continue to do QE.
Don't expect EMs (specifically China) to be the knights in shining armour: Back in 2009, China increased the flow of credit substantially, while India and the rest of the EM world eased monetary and fiscal policy to historical levels. This time round, most EM policy-makers still seem to be on the path to doing just enough to support their own economies.
The policy response: Six EM central banks under our coverage have delivered policy rate cuts in the past few months. The strategy from the other EM central banks has been to: i) let markets implicitly 'ease' by not standing in the way of rate cuts being priced in; and ii) try to use intervention in the FX markets to prevent further currency weakness. As EM growth and inflation ease in 2012, our economics teams see further policy rate cuts from ten central banks. Monetary policy-makers likely believe that their tightening cycle has been interrupted and are reluctant to ease aggressively while inflation is still relatively high - the exceptions here being Brazil and Indonesia. Others may wish to ease but are constrained by concerns about further aggravating the ongoing currency weakness. Hungary is clearly the worst affected by currency concerns while Turkey has raised domestic borrowing rates, but others in the CEEMEA region and even the likes of Mexico have been worried about cutting rates, lest it exacerbate currency weakness. Most EM economies remain in a comfortable fiscal position, but are reluctant to ease fiscally, given the aversion of financial markets to weak sovereign balance sheets. Nevertheless, some fiscal slippage cannot be ruled out as some push the task of further consolidating deficits a little more into the future. For the all-important case of China, our AXJ team continues to see targeted easing, with SMEs given increasing support.
The window to be pre-emptive is slowly closing: During the 'soft patch' in growth in 2010, EM central banks were able to get by without doing much because the Fed and the ECB aggressively manned the money pumps, leading to weaker DM currencies which kept EM currency crosses from falling, and the monetary policy stance of EM central banks themselves was much more accommodative. Now, we expect the Fed and the ECB to join the BoE in providing another round of QE, but the timing and the size of these programmes remain uncertain. To the extent that DM policy help isn't immediate or aggressive, we believe that EM policy-makers are better off buying insurance via pre-emptive easing. Should the fears about the downside risks to growth globally turn out to be unfounded, turning monetary policy around will not be relatively painless compared to downside to growth should these fears be realised, in our view. The more time that EM central banks spend on the fence, the later will domestic demand receive the support from monetary easing, thanks to the famous lags associated with monetary policy transmission.
Revising Down Our 2012 Forecasts Again
When we last revised down our growth forecasts in mid-August, saying that Europe was dangerously close to recession, some might have thought that we were a bit too gloomy (see Global Economics: Dangerously Close to Recession, August 17, 2011). It turned out that we were still too optimistic and hence we are forced to cut our 2012 GDP forecasts again. Instead of a phase of stagnation in the euro area's overall economic activity over the winter, we now expect an outright contraction for at least two consecutive quarters. Starting in 4Q11, we expect headline GDP to fall by a cumulative 0.75%. It is not before the second half of next year that we expect to see some growth again.
As a result, our full-year estimate for real GDP growth is reduced from 0.5% to -0.2% for 2012, making the current downswing more pronounced than in 2002/03 (see Europe Economics: Growth Coming to a Standstill, August 17, 2011). But, at the same time, we don't expect a replay of the 2008/09 slump. Below we give a number of reasons why one should not become too negative about the outlook. In fact, we believe that 2012 should be the year in which leading indicators for euro area bottom and economic activity trough - though we may have to wait for this turning point until 2H12. In our view, investors should not lose sight of this turning point, even though it might still be some time away and, at the moment, seems worlds apart from today's financial market turbulence.
First Glimpse at a Better 2013
Today we are also rolling out our 2013 forecasts for the first time. Globally, we expect GDP to expand by 3.9% in 2013, led by emerging markets growth and supported by the US. For the euro area, our first estimate of 2013 GDP growth comes in at a meagre 0.9% - which would be below consensus and below official forecasts to the extent that estimates are available already. In the course of next year and further into 2013, inflationary pressures should ebb in response to these cyclical developments and, if anything, HICP inflation will likely come in below the ECB's price stability norm, thus allowing the bank to ease monetary policy significantly in early 2012 to fend off potential downside risks to price stability. Given that monetary policy - like exchange rate movements - affects the economy with a time lag, the positive impact will only be visible in 2H12. In addition, we expect fiscal tightening programmes to be front-loaded across the euro area in response to current market pressures and the demands made by political peers. As a result, the fiscal drag in 2013 should be a touch smaller than in 2012, we think.
Reasons for Another Downward Revision
The reasons for another downward revision to our euro area growth outlook are not difficult to find:
• First, both business sentiment and consumer confidence have been taking another hit on the back of the renewed escalation and expansion of the financial crisis as the sovereign stress has started to eat its way deeper into the core of the euro area.
• Second, rising funding costs for all euro area sovereigns except Germany and Ireland (sic!) since the summer have started to push costs of capital higher for corporates; independent from whether they borrow via commercial banks or whether they access the capital market directly.
• Third, banks have started to tightening credit conditions again in the autumn and will have to deleverage aggressively in the months ahead in order to meet the 9% capital adequacy requirements by mid-2012.
• Last but not least, most governments have pencilled significant fiscal tightening into their 2012 budgets. For the region as a whole, we estimate the discretionary measures governments intend to implement coming to up to 0.75% of GDP. Only very few governments (e.g., Germany, Sweden) are able to let the fiscal stabilisers work fully in order to offset the impact of the upswing on domestic incomes.
On the Anatomy of Yet Another Recession
While we have reduced our forecasts across the region and now are also expecting an outright recession in the larger core countries, we made the biggest cuts to our 2012 numbers in the periphery, notably Greece, Spain and, to a lesser degree, Italy. As far as the periphery is concerned, we already called for a recession in our previous set of forecasts but have now been forced to call for an even deeper decline in activity.
Looking at the different demand components, we mostly cut our domestic demand estimates, reflecting the tightening in financial conditions, falling equity markets and in some places house prices. Consumer spending will bear the brunt of the additional fiscal austerity, deteriorating labour market prospects and households debt deleveraging. Investment spending, notably machinery and equipment, will be hit by the slowdown in global trade, the tightening in credit conditions and the increase in uncertainty about the political course of action. Construction investment will likely shrink as well due to falling corporate investment, government cutbacks and sluggish residential activity. Government spending should also weaken on the back of the fiscal consolidation across the euro area.
Even Germany is unlikely to escape the recession, we think. This is because Germany is twice as export-oriented as other large European countries, with exports of goods and services accounting for more than 40% of GDP and the majority of the German exports going to the rest of Europe. In addition, Germany's economic structure is still heavily biased towards the industrial sector, which makes the economy exhibit a higher beta in its business cycle than many of its peers. If the financial crisis spreads also to the German government bond market - something that we cannot rule out, given that Germany also has no access to a lender of last resort and given that market sentiment towards sovereigns has become fickle - the impact on the financial sector would likely introduce some serious downside risks to our numbers.
In France, this process already seems to be in motion and, based on the Eurosystem's bank lending survey, French banks seem to be the ones that are tightening their credit conditions most aggressively. Hence, even a less cyclical economy such as France will likely be hit and we have revised down our forecast for 2012 to 0.3% on the back of a mild recession this winter. Risks to our scenario are tilted to the downside, as persistent stresses in the funding markets may force banks to tighten their credit conditions, which is likely to aggravate the economic downturn. Domestic demand is likely to remain sluggish over the forecast horizon. Private consumption is expected to grow at a much slower pace than its historical trend. After a contraction in the second half of this year, we see corporate investment picking up slightly in 2012. While the government is committed to continue fiscal consolidation in the medium term, we think that a pro-cyclical fiscal policy may lead to an ‘austerity trap' as the public deficit is projected to decline to 5% of GDP in 2012, from 5.8% in 2011. As we think growth is likely to be lower than the 1% expected by the government, further austerity might be required to achieve the deficit target of 4.5% of GDP in 2012, which, in turn, could further weaken growth.
While the newly appointed Monti government might focus on pro-growth reforms further down the line, Italy's near-term outlook will likely be driven by further belt-tightening measures, thus putting the economy deeper into recession. We now expect an outright contraction in GDP of a full percentage point in 2012 and a quasi-stagnation the following year. Digging deeper into Italian households' pockets seems to be the form that financial repression will take, probably through wealth/property taxes, pension reforms, benefit reductions and a further VAT rate hike. More austerity means that the budget deficit will narrow, but meeting the fiscal targets looks ambitious to us without additional measures. Given economic weakness, tax revenues might disappoint expectations, though Italy has considerable room for manoeuvre in other areas, such as asset sales. Although Italy has to do its homework to make sure that it does not reach the limits of fiscal sustainability, a quick return of confidence, partly connected to a European policy response, is a crucial element to avoid self-fulfilling prophecies such as a buyers' strike. But, even at this level, higher sovereign spreads mean tougher funding conditions for the banks. With credit standards tightening once again, the risk of a full-blown credit crunch, which will negatively affect the economy even further, is material, in our view. The export outlook, given the considerable growth slowdown in Germany and France, looks weak too.
With deleveraging continuing for quite a while, we think Spain is unlikely to become a quick turnaround story. We now expect the economy to re-enter recession this winter. While the economic landscape remains highly fragile, the policies that the new government will have to implement to bring unemployment down are a key variable to watch, along with market support to the Spanish bond market through the ECB's Securities Market Programme. However, the government will only become fully operational in a few weeks. Spain entered the crisis with very low public sector leverage and an overall budget surplus. However, it has already exhausted any room for fiscal manoeuvre and government indebtedness, while still below the eurozone average, is on the rise. Further austerity measures will likely be announced, in order to tighten the belt to a greater extent after a probable miss of this year's fiscal targets, due to difficulties in controlling regional and health spending. While the rationale for these policies is sound, this will further hit consumer spending. The correction in construction investment is quite advanced, but private sector deleveraging - from households and corporates to banks - is likely to continue for a long while. What's more, the external sector, which performed quite well during the past year, has already started to weaken, given weak growth in Spain's key markets.
An Aggressive ECB Policy Response Becoming Likely
In our view, the ECB will likely respond to the rising risk of a recession with additional refi rate reductions (indeed there was a 25bp cut on December 8). Further rate cuts, which would bring the refi rate to new historical low of 50bp and the total ECB easing to 100bp, are likely to follow in early 2012, we think. Next to that, additional funding support for banks, which are still cut off from wholesale funding markets, looks increasingly likely to us. This support could include additional LTROs, possibly at extended maturities. Alternatively, the ECB could open a new medium-term funding facility for banks. Beyond bank funding, the bank could also engage in additional buying of bank bonds over and above the relaunched covered bond buying programme, which could even be extended to unsecured bank bonds, if needed.
Eventually, however, the ECB would face the question whether to buy government bonds in size without sterilising the purchases - a step that many market participants loosely refer to as QE. In our view, the ECB would likely go ahead with such purchases only if it had exhausted its traditional ammunition but would still see downside risks to price stability. The QE decision would also depend on market conditions, the effectiveness of the aforementioned stimulus measures and on the broader political backdrop. Hence, whether the ECB starts a QE programme sometime next year remains a close call. The hurdle to QE is higher than elsewhere, we think, because the ECB is explicitly banned by the EU Treaty from acting as a lender of last resort to governments (see EuroTower Insights: Fiscal Union Needs Monetary Back-Up to Solve Crisis, September 22, 2011). While in theory it is easy to distinguish between bond purchases intended to pump liquidity into the financial system from purchases intended to provide funding to governments, in practice when a central bank buys a government bond it effectively does a bit of both. This blurred boundary to monetary financing of government debt is likely to be at the heart of what would likely be a controversial debate within the Governing Council. In order to make clear that the purchase programmes serve a monetary policy purpose and do not constitute a fiscal funding fix, any asset purchases would likely be done on a pro rata basis across countries and maturities, we believe, rather than just coming as a much larger, unsterilised SMP. At the same time, however, we expect the ECB to continue with its SMP purchases to prevent the peripheral markets from becoming even more disorderly.
Reasons for Not Getting Too Pessimistic
Faced with the prospect of a recession, it is often difficult for investors and forecasters not get sucked into a spiral of negativity about the cyclical outlook. But, in our view, it is important to not lose sight of a number of factors that should act as a cushion against the downdraft in the quarters ahead.
• First, robust global growth, according to the estimates of our colleagues in the Americas and in Asia, should support external demand as the global economy is still estimated to expand by 3.5% next year, which is only a touch below the long-term average (see Global Forecast Snapshots: Outlook 2012: Policy Make or Break, November 27, 2011).
• Second, a marked weakening in EUR in the course of next year, according to the revised forecasts of our FX strategy team, which puts EUR/USD at 1.20 in December 2012 (i.e., 9.8% below today's level), should cause euro area monetary conditions to become more expansionary. On the ECB's own estimates, a weakening in EUR by 10% adds 0.7% to GDP in the first year and 1.2% in the second).
• Third, additional easing by the ECB in terms of rate cuts and in terms of funding support for euro area banks should add to the monetary stimulus, we think. Historically, 100bp of ECB rate cuts has boosted GDP by 0.2% in the first year and 0.4% in the second.
• Fourth, while bank deleveraging is a major headwind in the near term, a considerable part of it might actually come from assets other the core loan book and be largely completed by mid-2012 when the new EBA targets have to be met (see European Banks: What Are the Risks of EUR1.5-2.5tr Deleveraging? November 14, 2011). Putting our banks team's estimates of up to €2.5 trillion into perspective, which is half the balance sheet shrinkage we saw in 2008/09, we find that bank lending to the private non-financial sector fell by about 1% peak to trough at that time. Such a decline in loan supply would normally reduce GDP by only 0.5pp.
• Fifth, remembering lessons from 2008/09, corporates have strengthened their balance sheets and are managing their working capital requirements more aggressively than ever. Where possible, corporates have been exploring avenues of funding that side-step the banking sector, including accessing the capital directly, using internal cash flows and providing funding along the supply chain. In addition, many governments or government-backed banks and the EIB still offer dedicated SME funding programmes.
Significant Risks Remain in Our Bear Case
Our base case is that of a relatively benign recession in the coming quarters. There can be no mistaking the downside risks to our base case though. One of the main swing factors are the political decisions being taken in the next few weeks, both by the ECB and by European governments. The assumption underlying our base case growth projections is that the sovereign crisis won't be allowed to escalate further but that it won't dissipate quickly either. In the interests of providing a ‘clean' reading of the cyclical dynamics we have to assume continued ‘muddling through' even though this piecemeal policy is being challenged by financial markets. Hence, the risks to our forecasts remain asymmetrically tilted to the downside. Our bear case is one where Europe falls into a much deeper recession and real GDP contracts around 3% from peak to trough - consistent with a 2% decline on average in 2012. In this case, we would likely also see Europe falling into outright deflation in 2013. In this case, the ECB would likely respond by aggressive QE after it has exhausted all other policy measures - notably reducing the policy rates as closely to zero as it is technically feasible and providing as much funding support to the banking system as needed, which might mean that the ECB will have to replace all wholesale funding. Once these measures have been exhausted and the deflation risk still persists, the ECB would have no choice but to embark on an active QE programme, which, contrary to its previous QE strategy, works via outright asset purchases rather than refi operations (see EuroTower Insights: Not Quite QE, May 13, 2009).
The Global Economic Environment and Japan's Economy
Despite reconstruction demand, we believe that Japan's economy is heading for below-consensus low growth in 2012, given the weakening global outlook. Still lower growth will follow in 2013 as the effects of fiscal contraction in Japan and abroad emerge. We keep our 2011 GDP forecast of -0.4% (F3/2012: +0.2%), but come down 0.2pp to +1.1% for 2012 (F3/2013 +1.0%), and assign a 2013 forecast of +0.5%.
Our global teams have revised down 2012 GDP forecasts to modest negative growth (-0.2%) for the eurozone, beset by sovereign debt problems (previous forecast: +0.5%), and to +8.4% for China (previous: +8.7%), reflecting deceleration in domestic demand (fixed asset investment) and external demand. In the US, the bipartisan Super Committee charged with reducing the fiscal deficit failed to reach any agreement, shelving until year-end any resolution of payroll tax cut and unemployment benefit extensions. There is risk in either direction for the US economy depending on the spending outlook, including these measures: our economists see upside risk to 2.7% growth in the event of extensions for 2012, and downside risk to around 0.6% in the event that both the payroll tax cuts and benefit extensions are discontinued. The Super Committee's failure to find common ground would appear to tilt the risk profile towards the downside. Taking these circumstances into account, our global economic growth forecast for 2012 has been revised down by 0.3pp to +3.5% (from +3.8%).
Japan's Economy in 2011-12
Japan's annualised GDP growth in Jul-Sep 2011 was a high 6.0%, reflecting the rebound in economic activity following the earthquake, but economic deceleration abroad is slowing the production and export pick-up, putting Oct-Dec on course for annualised growth near zero. The flooding in Thailand is expected to affect production and, with mounting financial constraints, our European economics team is expecting negative growth in Europe during Oct-Dec and Jan-Mar 2012. Although the US is seeing an unexpected pick-up centered on consumption in Oct-Dec, we look for annualised growth to slow to below 1% in Jan-Mar as fiscal stimulus wears off. Clearly Japan will be affected by this stagnation spreading in the global economy, and especially the US and Europe, in Jan-Mar 2012. The Thai floods are also depressing domestic production in the short term, though as we saw with supply chain problems for the auto industry after the earthquake, production levels rebound once issues are resolved, so the flooding is probably neutral for Japan's economy on a 6-12-month view.
With support from public demand as funds from a third F3/12 supplementary budget to finance post-quake reconstruction are disbursed, we expect annualised growth at a +1% level from the Apr-Jun 2012 quarter onwards. However, with the three risks we identified materialising - (1) decelerating global growth, (2) delays in implementation of fiscal support, and (3) power shortages in the medium/long term - we foresee growth undershooting consensus expectations.
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