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OECD Boosts Forecasts in May Report

OECD Boosts Forecasts in May Report

2010-05-26 19:26:00
Christopher Vecchio, CFA, Sr. Currency Strategist

While capital flows between G7 countries and emerging markets are helping pull the world out of the recession, volatile credit markets, coupled with overheating in emerging markets leading to potentially dangerous inflation leave room for another dip in the recession. According to the OECD, should a scenario like this occur, many European countries, emerging market economies and countries that have not seen a return to growth yet will be negatively affected. Some excerpts from the OECD Economic Outlook:

OECD Forecast Table_May 2010_1

United States

The recovery that began in the middle of 2009 is expected to continue through 2010, and equilibrium will return sometime in 2011. However, return to growth is contingent upon net job creation, which has only recently resumed in the past few months for the United States. The OECD firmly believes that the Federal Reserve will need to begin to wind down its quantitative easing program shortly, but, given the instability and volatility of the financial sector, it does not advise to do so until bank lending conditions have been normalized.
Monetary policy remains on the right course as weak inflationary pressures and a constant current account deficit necessitate the need for policy stimulus. The recovery is gradual in the Euro-zone, not nearly as strong as its American counterpart, but the area currently faces strong financial market instability than anywhere else in the world. Should the European Central Bank continue to struggle with restoring competitiveness to the public financial sector, then a recovery will be muddled. Furthermore, in order to support a weak financial system, the OECD believes that the European Union needs to establish a financial regulatory authority to reduce further risks of crisis.
United Kingdom
Great Britain is recovering better than expected, propped up by improving financial conditions, stronger capital inflows, and a rebound in the current account. Growth in 2010 will be tempered as the effects of high inflation remain after the credit crunch, though a full recovery will be underway in 2011. Unemployment is expected to drop significantly after peaking sometime in the next few months, which falls in line with the anticipated relaxation of price pressures, which should bring inflation under the 2.0 percent Bank of England threshold. The OECD believes that the key to recovery among English financial institutions is fiscal consolidation, as dictated by increasing bond yields. Accordingly, monetary policy should remain expansionary in order to support low levels of resource utilization.
A current account surplus and continued fiscal stimulus are leading the way for Japan’s return to growth. The biggest consequences to the Japanese consumer resulting from the recession were that unemployment and wages dropped simultaneously, leading to lower disposable income. Should output reach the OECD’s target of 3.0 percent this year, and plateau around 2.0 percent in 2011, there could be a slight rebound in the labor market; the OECD does not believe that the unemployment rate will drop below 4.5 percent in 2011, however. Deflation remains a potential obstacle for Japan, and the OECD proposes that the Bank of Japan continues their quantitative easing measures for some time until underlying inflation returns to more normal levels. Overall, Japan’s policies should be geared towards boosting productivity in the service sector, while working to return lost income to households.
The Canadian economy is rebounding rapidly thanks to a recovering trade sector and joint monetary and fiscal policy measures that have proved extremely effective. As the Bank of Canada winds down stimulus, growth is expected to remain moderate over the next two years, and the labor market will rebound accordingly over this period. Given Canada’s strong standing, the OECD finds that it is time for the Bank of Canada to begin unwinding policy measures over the course of the two-year projection period.
China’s vigorous expansion, despite the recession, continued throughout 2009 and thus far into 2010. Gross domestic product growth is expected to accelerate past 11.0 percent this year before finally slowing down to approximately 10.0 percent in 2011 as the People’s Bank of China tightens banking requirements yet again. The economy is showing signs of overheating, as inflation is catching up with the rapid expansion. Until China moves towards a more neutral monetary policy stance, inflation is expected to become more problematic. The OECD notes two possible solutions to this: an increase in interest rates, or, greater flexibility in their fixed exchange regime which would allow the renminbi to appreciate against a basket of currencies.


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