Fitch: Strengthening Recovery in Advanced Economies

Fitch Ratings says in its latest Global Economic Outlook (GEO) that world GDP growth will strengthen to 2.7% in 2015 and 3.0% 2016, up from 2.5% in 2014, driven by recovery in major advanced economies (MAE). Growth will increase this year in all three of the largest advanced economies (US, the eurozone and Japan) for the first time since 2010. However, emerging markets (EM) will continue to slow owing to recession in Russia and Brazil and the structural adjustment in China.

Fitch's global growth forecast (which is weighted at market exchange rates) has weakened since December's GEO by 0.2pp for 2015 - due entirely to EM revisions - and is unchanged for 2016.

For the US economy, Fitch maintains its forecast of robust GDP growth of 3.1% in 2015 and 3% in 2016, the strongest among MAE, up from 2.4% in 2014. Private consumption will remain a key growth driver, supported by lower oil prices, higher household disposable income and a strengthening labour market, while export performance will be constrained by the appreciation of the USD.

In the eurozone, the steep drop in oil prices, ECB's launch of quantitative easing (QE), euro depreciation and improving confidence support Fitch's forecast of a gradually strengthening recovery to 1.4% in 2015 and 1.7% in 2016, from 0.9% last year. This is an upward revision of 0.3pp for 2015 and 0.2pp for 2016 since the December GEO. Nevertheless, growth will remain modest compared with other MAEs, the effectiveness of QE is uncertain and it remains to be seen whether a robust, self-sustaining recovery takes root. The growth pattern remains unbalanced within the currency union with Italy and France lagging eurozone average growth until 2016.

Emerging markets are experiencing a general slowdown and even recession in some key countries. Fitch forecasts EM GDP growth, which peaked at 6.9% in 2010, to slow to 3.6% in 2015, before edging up to 4.2% in 2016. We forecast Russia to enter a deep recession of 4.5% in 2015 and 1% in 2015. Brazil has been in recession since mid-2014 and is forecast to contract by 0.4% in 2015 and to grow by just 1.5% in 2016. China's gradual slowdown is structural as reforms take effect, and we maintain our growth forecasts at 6.8% in 2015 and 6.5% in 2016. India is the only BRIC where growth will accelerate to 8% in 2015 and 8.3% in 2016, based on updated national accounts data.

Japan is forecast to return to above-trend growth of 1.3% in 2015 and 1.5% in 2016, supported by currency depreciation and higher real wages after an unexpectedly weak 2H14. Growth will remain robust in the UK as GDP is forecast to grow by 2.5% in 2015 and 2.3% in 2016 following 2.6% in 2014.

Fitch forecasts inflation in MAEs at just 0.3% in 2015, the lowest in the modern era except for 2009. This reflects not only the steep fall in oil prices, but also subdued underlying inflation amidst strengthening recoveries and a fast reduction of labour market slack. Furthermore, longer term inflation expectations as measured by financial markets have also fallen to historical lows not just in the eurozone, but also in the US and the UK.

Disconnect between real and inflationary developments heighten the challenges facing the Fed and the Bank of England in normalising monetary conditions. Fitch expects the Fed to start raising interest rates in mid-2015 and to follow a gradual tightening path, leading to an average policy interest rate of 1.6% in 2016. The difference in expectations of the path of rate increases of members of the Fed Open Market Committee (as embodied in the "dot plot") and that implied by current market bond yields indicate a risk of market volatility.

The ECB and the Bank of Japan will keep interest rates at the lower bound at least until the end of 2016 and continue their QE programmes. Divergent monetary policies in MAEs add to risks of financial market volatility and EM policy mistakes and adverse growth shocks.

The large, recent swings in exchange rates are driven mainly by the expectation of divergent interest rate and growth paths in MAEs. However these movements look at odds with some long-term economic fundamentals and could lead to widening global current account imbalances. This GEO's alternative scenario illustrates that a sudden closing of real exchange rate misalignments, measured as the difference between actual and the estimated equilibrium values, could result in a recession in Germany and slower growth in Japan, while the impact would be small in other MAEs and EMs.