Global Outlook

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Global outlook
Key changes since November 12th 2010
• The Economist Intelligence Unit has revised upwards its 2011 forecast for US GDP growth from 1.5% to 2.2%. The extension of the Bush tax cuts, a cut in payroll taxes and extension of unemployment benefit will boost demand by around 0.5 of a percentage point in 2011. The upward revision to the US forecast has pushed up our global growth forecast to 3.8% (at purchasing power parity exchange rates), from 3.7% previously. The EU-IMF loan package to Ireland is unlikely to draw a line under the crisis of confidence affecting the euro zone periphery. We expect Portugal to require assistance in early 2011. We assume that Spain will manage without official funding, although both the sovereign and Spanish banks face huge debt rollovers in the first half of 2011. Bond yields in the US, Europe and Japan have risen sharply since mid-October 2010. This raises doubts about the effectiveness of the Federal Reserve's decision in early November to expand its programme of asset purchases. Yields remain low by historical standards but further increases could hinder a recovery in bank lending as well as exerting pressure on valuations of risky asset classes. Strong demand and higher fuel and food prices pushed up inflation in China to 5.1% in November last year. The authorities are reponding with measures to rein in bank lending. Recent data indicate of loss of momentum in some emerging markets, such as South Korea, which is typically a bellwether for global industrial output. We assume that this is a soft spot, related to the inventory cycle, and that the global recovery will be sustained in 2011. Even with the upward revision to the US, emerging markets will again account for the lion's share of global growth in 2011. Oil consumption is currently growing at a strong pace, validating the recovery in prices from the lows reached in early 2009. Our oil forecasts remain unchanged: Brent is forecast to average US$82/b in 2011, up from US$80/b in 2010. There is some upside risk to this forecast if demand maintains its current momentum.











January 2011
Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom

Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For 60 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group. London Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom Tel: (44.20) 7576 8000 Fax: (44.20) 7576 8500 E-mail: [email protected] Hong Kong Economist Intelligence Unit 60/F, Central Plaza 18 Harbour Road Wanchai Hong Kong Tel: (852) 2585 3888 Fax: (852) 2802 7638 E-mail: [email protected] New York Economist Intelligence Unit The Economist Group 750 Third Avenue 5th Floor New York, NY 10017, US Tel: (1.212) 554 0600 Fax: (1.212) 586 0248 E-mail: [email protected] Geneva Economist Intelligence Unit Boulevard des Tranchées 16 1206 Geneva Switzerland Tel: (41) 22 566 2470 Fax: (41) 22 346 93 47 E-mail: [email protected]

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Global outlook

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Contents
2 11 37 39 41 46 World growth and inflation Regional summaries Exchange rates World trade Commodity prices Global assumptions

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World growth and inflation
(Forecast closing date: December 10th 2010)
World summary
(% change) 2006 Real GDP growth (PPP exchange rates) World OECD Non-OECD Real GDP growth (market exchange rates) World North America Western Europe Transition economies Asia & Australasia (incl Japan) Latin America Middle East & North Africa Sub-Saharan Africa Inflation (av) World OECD Trade in goods World Developed countries Developing countries
Source: Economist Intelligence Unit.

2007 5.2 2.7 9.2 3.9 2.0 2.8 7.6 6.4 5.6 5.3 7.0 3.4 2.1 7.7 5.1 11.9

2008 2.7 0.3 6.2 1.5 0.0 0.3 4.5 2.8 4.0 5.9 4.9 4.9 3.2 3.8 0.8 8.2

2009 -0.8 -3.4 3.0 -2.2 -2.6 -4.2 -5.6 0.7 -2.1 1.4 0.8 1.5 0.0 -11.1 -12.4 -9.2

2010 4.7 2.7 7.2 3.6 2.7 1.9 3.0 6.2 5.6 4.1 4.2 2.9 1.3 12.4 11.2 13.9

2011 3.8 1.8 6.3 2.7 2.2 1.2 3.5 4.4 3.8 4.3 4.6 2.7 1.1 5.9 4.4 7.9

2012 4.0 2.0 6.5 2.9 2.2 1.5 3.9 4.5 4.0 4.4 5.5 3.0 1.7 6.3 4.0 9.2

2013 4.1 2.2 6.4 3.0 2.3 1.8 4.1 4.3 4.3 4.4 5.0 3.2 2.0 6.7 4.7 9.1

2014 4.2 2.2 6.4 3.0 2.2 1.7 4.1 4.3 4.4 4.6 4.8 3.3 2.1 6.7 4.7 9.2

2015 4.3 2.1 6.2 3.1 2.5 1.7 4.0 4.4 4.4 4.7 4.8 3.4 2.3 6.3 4.4 8.7

5.1 3.1 8.5 4.1 2.7 3.2 7.5 5.7 5.5 5.9 6.7 3.3 2.2 9.1 7.2 12.3

Concerns about the risk of a double-dip recession, which roiled financial markets in mid-2010, have given way to a more optimistic outlook and a renewed phase of risk-taking. The tone of economic data in the US remains lacklustre, but overall the picture is one of a continued expansion into 2011 rather than a renewed contraction of output. Meanwhile, concerns in mid-2010 about a slowdown in China stemming from a contraction in the property market have been allayed by renewed strength in a range of indicators, including manufacturing and trade data. Now the main concern in China stems from growth being too strong, creating inflationary pressures and possibly causing policymakers to respond by tightening policy too abruptly.
The US jobs market fails to gain traction

US jobs data, among the indicators most eagerly awaited by financial markets, remain mixed. A positive non-farm payrolls release for October 2010, reporting the creation of 151,000 jobs, suggested that companies were finally putting caution behind them and hiring again. But the November non-farm payrolls report brought disappointment. It reported new jobs of only 39,000, far short of market expectations of around 200,000 and too low to make inroads on unemployment, which edged up to 9.8% during the month. The US Federal Reserve Reserve (Fed, the central bank) is responding to the weakness of the labour market and very low readings of core inflation by keeping monetary policy highly expansionary. In early November 2010 it

Editors: John Bowler, Daniel Martin (editors); Caroline Bain, Aidan Manktelow (consulting editors) Editorial closing date: December 10th 2010 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: To request the latest schedule, e-mail [email protected]
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announced an expansion of its programme of quantitative easing (QE2). It plans to buy an additional US$600bn of US Treasury bonds between November 2010 and mid-2011 (a rate of around US$75bn a month). It will also continue to reinvest the principal repayments of maturing Agency debt and mortgagebacked securities in its portfolio. In total, this adds up to between US$850bn and US$900bn of purchases by the end of the second quarter of 2011. The Fed intends to make the bulk of the purchases (86%) in maturities ranging from two and a half years to ten years. The Bank of Japan (BOJ, the central bank) announced its own—much smaller—QE programme in early October, while some members of the monetary policy committee of the Bank of England (BOE, the UK's central bank) are arguing in favour of expanding the UK's QE programme. The Economist Intelligence Unit expects the BOE to resume QE in the first half of 2011. The combination of positive, albeit subdued, growth and exceptionally loose monetary policy in much of the West has been creating a positive climate for risky assets (equities, commodities and emerging-market assets), which have rallied strongly since last July. Creating a "wealth effect" through higher asset prices is meant to be one of the transmission mechanisms through which QE works. However, it is noteworthy that since the Fed announced an expansion of QE, the dollar has stabilised and US Treasury yields have risen (continuing a trend of the previous month), even as risky assets such as commodities and equities have made further gains. This may be because the markets had more than priced in the impact of QE2 on the foreign-exchange and US Treasury markets. But it also appears to reflect market concern about the inflationary risk posed by unorthodox monetary stimulus. It is too soon to reach a view on whether QE2 will work, but risky assets would struggle to make headway if bond yields were to continue rising. An upward revision to GDP data for the third quarter of 2010 shows that the US economy grew by an annualised rate of 2.5%, compared with a preliminary estimate of 2%. This was an improvement on the 1.7% rate in the second quarter. But it is disappointing by comparison with the normal rate of expansion at this point in a recovery cycle, when the economy would typically be growing at around 5%. Economic activity is being constrained by the renewed deterioration in the housing market, sluggish job creation in the private sector and the ebbing of the impact of fiscal stimulus. Hence the Fed's decision to expand its programme of asset purchases.
In Germany, the recovery broadens out as consumption picks up

In contrast to the US and to some of its euro zone peers, Germany's economy has been doing very well. It expanded by 2.2% in the second quarter of 2010 in quarter-on-quarter terms, the fastest growth rate since reunification. The rate of growth slowed to 0.7% in the third quarter but still leaves Germany on track to grow by over 3% in 2010. Germany's strong rebound was initially built on a stimulus-induced bounceback in world trade growth. But in recent months there has been evidence that growth is broadening out and that domestic demand is playing more of a role. Chinese growth slowed to 9.6% year on year in the third quarter, down from 10.3% in the second quarter. The slowdown follows the introduction of measures to cool the property market, through increases in banks' reserve require-

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ments, interest rates and curbs on bank lending. A rise in inflationary pressure in recent months is likely to force the Chinese authorities to take further measures to cool the economy. This creates the risk of policymakers tightening too much. Our forecasts assume that the Chinese authorities will calibrate policy correctly, ensuring that the economy continues to grow at 8.9% in 2011, despite the slowdown in the West.
Ireland accepts a €85bn EU-IMF financing package

Doubts about the viability of the euro zone persist. In November last year concerns about Ireland's solvency in the light of the government's pledge to guarantee all the liabilities of Ireland's stricken banks pushed yields on Irish sovereign debt to record levels. This contributed to an increase in yields on Portuguese bonds, and also those of the much larger economies of Spain and Italy. The sell-off of euro zone peripheral government bonds was accompanied by a decline in the euro. As concerns about Ireland spread to other countries, the Irish government came under pressure to apply for financial assistance. It resisted for some time but gave way in late November, applying for, and receiving, a €85bn package of financial assistance from the EU and IMF. The EU-IMF programme encompasses austerity measures and a plan to recapitalise and shrink the balance sheets of its banks. The government, which is certain to lose office in elections in early 2011, is in the process of presenting the budget, including these measures, to parliament. If the budget is not approved, this would create renewed uncertainty and turbulence in financial markets. EU policymakers hope that the Irish financing package will contain the problem. But it seems highly probable that Portugal will also need to tap official funding. In early December 2010 10-year Portuguese government bonds were yielding 6.08%, a spread of 320 basis points over equivalent German bunds. Bond yields at these levels effectively price Portugal out of funding markets. The same applies to Portuguese banks, which remain dependent on the liquidity facilities of the European Central Bank (ECB) for funding.

Preventing the funding crisis spreading to Spain will be critical

A more critical test will be whether Spain, which is almost two times as large an economy as Greece, Ireland and Portugal together, can get by without official financing. Spain's government and banks have very large funding needs in the first four months of 2011. Yields on Spanish government bonds had risen to 5.2% in early December, more than 100 basis points higher than a month earlier. They will have to fall if Spain is to meet its funding needs in the coming months. If Spain does require official financing, the EU will have to increase the total amount of financing available. Currently, taking account of the €85bn offered to Ireland, around €600bn in total is available out of the original package of €750bn. It is unclear whether Germany would approve of a further increase in financing for distressed euro zone members. Another possibility would be for the ECB to relieve funding pressures by adopting a full version of quantitative easing and making large purchases of government bonds, as opposed to the relatively small-scale purchases (of around €65bn) that it has made to date. Again, such a policy might not meet with the approval of core euro zone members. Sentiment towards Spain improved in mid-2010 as the government took measures to reduce the fiscal deficit and consolidate the troubled savings bank sector (cajas de ahorros). But the renewed rise in Spanish bond yields in

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response to Ireland's problems has shown the fragile nature of sentiment towards the euro zone periphery. Italian bond yields have also risen in recent weeks, as have those of Belgium, underscoring the potential for the problem to spread through contagion if EU policymakers fail to restore confidence in the euro zone.
Emerging markets show signs of a loss of momentum

Emerging markets (with the exception of much of eastern Europe, which is constrained by an ongoing public- and private-sector balance-sheet adjustment) rebounded strongly in 2010. Indeed, such has been the strength of the recovery that many, particularly in Asia's open economies, had, by end-2010, fully recouped the ground lost during the global recession in 2009. However, recent data suggest that a number of countries have lost momentum since the middle of the year. For example, South Korea, a good proxy for the global manufacturing cycle, slowed to 0.7% in the third quarter, on a seasonally adjusted basis. This was down from 1.4% in the second quarter and 2.1% in the first quarter. Our forecasts assume that the slowdown in South Korea and elsewhere is part of a transition to a more sustainable growth trajectory, following the V-shaped recovery that many emerging markets experienced in 2009 and the first half of 2010. In China, which overtook Japan in the second quarter of 2010 to become the world’s second-largest economy, our forecast assumes that policymakers succeed in boosting domestic demand sufficiently to offset the weakness in developed export markets. However, there is a risk of a crash in the frothy property market. This would undermine consumption just as the effect of the stimulus package is waning. A property crash in China would have far-reaching ramifications, not least for commodity producers, which would suffer steep declines in income as a result of lower prices and volumes. With virtually free money available from the main central banks, emerging markets are likely to attract large amounts of capital. This will fuel domestic demand but will create policy challenges as capital inflows bring with them the risk of inflationary pressures, currency appreciation and asset price bubbles. Hence the criticism of the Fed's decision to expand QE from policymakers in several emerging markets, including China and Brazil. In the light of the somewhat stronger tone to US data in recent months and measures agreed in early December between the administration and Congress (the extension of the so-called Bush tax cuts, an extension of unemployment benefit measures and a 2% reduction in payroll taxes), we have revised up our US growth forecast for 2011 to 2.2%. Also, we now assign only a 10% risk (previously 30%) to a double-dip recession. The policy measures being adopted (an expansion of QE and further fiscal loosening) will provide a short-term lift to consumption, but they fail to address structural weaknesses in the US economy (poor infrastructure and skills shortages). Despite our more sanguine short-term growth outlook, we remain of the view that medium-term growth prospects will be constrained by the overhang from the bursting of the credit bubble.

The West faces a protracted deleveraging cycle

Private-sector balance sheets in a number of major economies have improved since the height of the crisis, as households have retrenched and repaid some of

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their debts. Moreover, in both the US and the euro zone bank lending has stopped declining on a year-on-year basis. But the process of deleveraging is far from complete, and is likely to last for several more years. It is a necessary adjustment after the excesses of the credit boom, but it creates the risk of a protracted period of large output gaps and high unemployment. In the US, in particular, non-financial firms have liquid balance sheets and are sitting on record levels of cash. Once business and consumer confidence improves, firms would face few constraints to start hiring and investing. One of the reasons that firms are so liquid is the strength of corporate earnings, which have rebounded strongly this year and are now close to record levels. According to national accounting methodology, in the third quarter of 2010 pre-tax US corporate profits accounted for 14.5% of GDP, compared with a post-second world war average of 9.6%. Typically strong profits boost animal spirits and drive a recovery in hiring and investing, but this cannot be taken for granted. Some executives may exercise caution, taking the view that corporate profit margins at current elevated levels are unsustainable and that hiring and investing now may not generate sufficient returns. In 2009-10 governments stepped in to compensate for the reduction in private consumption and investment by running large fiscal deficits, thereby helping the global economy to avoid a depression. But the resulting deterioration in public finances has fuelled concerns about sovereign debt sustainability, primarly in the developed world where demographics are unfavourable and many countries have large unfunded pension and healthcare liabilities. These concerns are most acute in the euro zone periphery as member states do not have an option to devalue or to monetise deficits. But the problem is by no means restricted to the euro zone periphery. For example, in Japan the gross public debt in now around 200% and society is ageing rapidly.
Fiscal consolidation will subtract from growth in 2011

With the exception of the US, where the recent stimulus measures will keep the deficit large, there will be a marked tightening of fiscal policy in 2011 as governments respond with measures to reduce their primary fiscal deficits. The biggest adjustments will be made by countries most at risk, such as Ireland, Portugal and Spain. But other governments under less pressure from markets, such as the UK, have also announced tough fiscal consolidation measures. Some worry that the coming fiscal consolidation will snuff out the recovery. Others take the view that fiscal consolidation may not necessarily have an adverse impact on growth as it will ease household concerns about the future tax burden and reduce the risk of the government crowding out private borrowing. Such a fundamental split among economists is hardly conducive to policymakers navigating these turbulent waters without mistakes. While the finer points of this debate may ultimately remain unresolved, we believe that overall fiscal consolidation will subtract from growth in 2011. By contrast, monetary policy is set to remain exceptionally accommodative. Central banks will assume a greater share of the burden of supporting demand. We do not expect the Fed or its European counterpart, the ECB, to start raising their policy rates until the second half of 2012. The Fed's decision last November to expand its QE programme may not be the last. If unemployment stays high and deflationary pressures persist, further expansion cannot be ruled

A rise in bond yields raises concerns about the effectiveness of QE2

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out, although the recent rise in US Treasury yields may give the Fed pause for thought about the effectiveness of its policy. (By early December 10-year Treasury yields had risen by 60 basis points since the expansion of QE was announced on November 3rd. Bond yields had also risen sharply in Europe and Japan.) The ECB has held out against implementing QE, although it has purchased covered bonds, and since May last year it has been buying (and sterilising) purchases of Greek, Irish and Portuguese debt in an attempt to stabilise peripheral euro zone debt markets. The ECB is also providing large amounts of liquidity to the region's banks, and we expect it to continue to do so in 2011. If conditions in peripheral euro zone bond markets do not become less stressed in 2011, the ECB may begin large-scale government bond purchases.
The emerging world is strong, but faces structural challenges

The emerging world will again provide the principal support to global demand in 2011. Most emerging markets have been experiencing a vigorous recovery, which has taken output above levels reached before the crisis. Our forecasts assume that the recent loss of momentum in some emerging markets does not mark the start of a serious downturn. Growth in the non-OECD will slow in 2011 as the impact of fiscal stimulus and the inventory cycle fades, but will remain strong at just over 6% at purchasing power parity (PPP). This will help countries such as Germany and Japan, which depend on rising export penetration into the emerging world to drive growth, and highly indebted economies such as the US and the UK, where raising export growth is vital to help offset the weakness of domestic demand. Our forecast of a sustained recovery in emerging markets is not without risks. Many of these economies have been lifted by fiscal and monetary policy stimulus, which, given the lack of balance-sheet problems, has had a powerful effect on growth. It is unclear how emerging markets will cope with the withdrawal of this stimulus at a time when exports to developed-country markets— traditionally an important source of demand—remain subdued. Given the poor medium-term outlook for developed countries, emerging markets will need to make a structural shift, reducing their dependence on exports and generating more growth through domestic demand. While fiscal policy is definitely set to become less expansionary in the emerging world, the outlook for monetary policy is less clear. Exceptionally low policy rates and QE in the US and some other developed markets are likely to result in large capital inflows into emerging markets. Overall these will support demand, but they may lead to unwanted currency appreciation, generate inflationary pressure and fuel asset price bubbles. Like their peers in the West, emerging-market policymakers will face no shortage of challenges in 2011.

A moderate rate of expansion is forecast in 2012-15

In 2012-15 we forecast a decent rate of expansion for the global economy. A return to the heady growth rates before the crisis, which were only possible because of excessive credit growth, is not in prospect. The US will need several years during which private consumption grows by less than overall demand, while the public sector will also have to retrench in the medium term. In western Europe, fiscal tightening will weigh on growth in the medium term, not only in distressed peripheral euro zone countries but also in countries like France where the public debt burden has become uncomfortably high.

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Given more favourable demographics and stronger balance sheets, we expect emerging markets to continue to outperform. Asia will be the fastest-growing region, led by China and India. China will face some policy challenges. The labour force is set to stop expanding from 2011, which will push up the price of labour. This will encourage more balanced growth in China, with consumption accounting for a greater share of demand. A rebalancing of China's economy away from fixed investment and exports will help to alleviate imbalances in the global economy. But this will be a drawn-out process, and while imbalances persist they will bring with them the risk of trade and currency wars.

Risk scenarios
Events may diverge from the Economist Intelligence Unit's forecast in ways that affect global business operations. The main risks are represented by the following scenarios. Very high probability = greater than 40% likelihood that the scenario will occur over the next two years; high = 31-40%; moderate = 21-30%; low = 11-20%; very low = 0-10%. Very high impact = change to global annual GDP compared with the baseline forecast of 2% or more (increase in GDP for positive scenarios, decrease for negative scenarios); high = 1-1.9%; moderate = 0.5-0.9%; low = 0.2-0.5%; very low = 0-0.1%. Risk intensity is a product of probability and impact, on a 25-point scale.

Negative scenario—A number of developed sovereigns default as public debt spirals out of control
High probability; High impact; Risk intensity = 16 There are considerable concerns about the sustainability of public debt positions in a number of countries. Heavily indebted sovereigns—including developed economies, notably in the euro zone—could struggle to raise private financing even at higher interest rates, and some could default. Emerging-market defaults would create some ructions, but as developed-country sovereign bonds have traditionally been considered risk-free, defaults by such governments would wreak havoc on asset markets and investor psychology. Banks would face write-downs on their government debt portfolios, and financial sector guarantees by governments that default would be exposed as worthless. Financial systems would therefore come under renewed pressure, and there would be serious implications for economic growth.

Negative scenario—Tensions over currency manipulation lead to a rise in protectionism
High probability; High impact; Risk intensity = 16 Tensions are rising over attempts by some countries to weaken their currencies, and the US and China remain at odds over the value of the renminbi. A global "currency war" would raise the risk of protectionist responses. Greater protectionism would be disruptive for businesses. Some firms would be shut out of markets, others would see profitability hit by having to choose local suppliers over cheaper imports. Given the closely integrated nature of the global economy, governments would find it difficult to close off many aspects of trade. But trade disputes are likely to increase as populist policies clash with countries' international obligations. Large-scale protectionism would seriously slow economic recovery.

Negative scenario—New asset bubbles burst, creating renewed financial turbulence
High probability; High impact; Risk intensity = 16 Massive monetary stimulus, combined with the ongoing global recovery, has led to concerns about new asset bubbles particularly in emerging markets. Emerging-market assets have surged and other risky asset classes such as commodities have seen strong rebounds, and the risk of shocks to the global economy from market corrections is rising. New asset bubbles may be vulnerable to painful corrections as central banks in emerging markets tighten monetary policy, fiscal stimulus is withdrawn, and the weak foundations of recovery become apparent. The resultant dislocations, including a shock to banks and a renewed rise in risk aversion, would reinforce and deepen a renewed economic slowdown.

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Negative scenario—Developed economies fall into a deflationary spiral
Moderate probability; Very high impact; Risk intensity = 15 Deflationary pressures remain strong in key developed economies, and could yet overwhelm the policy response designed to prevent a deflationary spiral. Notwithstanding concerns on the part of some observers about the inflationary impact of loose monetary policy, we still see deflation as the greater risk, partly because policy can be tightened before inflationary pressures rise unduly. Deflation would blunt the effectiveness of macroeconomic policymaking, retard balance-sheet adjustment in highly indebted economies, and encourage consumers and firms to prioritise debt repayment over consumption. It would hit profits and lead to lower investment. If deflation were to take hold, the global economy would face prolonged stagnation.

Negative scenario—The global economy experiences a double-dip recession as stimulus fades
Low probability; Very high impact; Risk intensity = 10 Massive macroeconomic stimulus has stabilised the global economy and allowed growth to return. However, growth will slow into 2011 as the impact of the stimulus fades, because it takes time to absorb persistent fundamental imbalances. Our baseline forecast is for growth to weaken moderately in 2011 as stimulus is wound down; the risk is of a deeper downturn including renewed contraction in several leading economies. A new wave of countries, whose finances have been weakened by the earlier downturn, would require multilateral assistance, and companies that had barely survived the initial recession would fail.

Negative scenario—The Chinese economy crashes
Low probability; Very high impact; Risk intensity = 10 China's economic growth rates have been spectacular, and among the quickest in the world to rebound to pre-crisis levels. The country is key to the global recovery. However, booming property prices and a construction boom raise the risk of a sharp correction to the property market, with implications for the whole economy. Although the risks to China's economy are greater in the long term, growth could slow sharply in 2011. The dangers to the economy would be compounded by a double-dip recession in developed markets or a rise in protectionism. China's fiscal position remains strong, but it is questionable whether the government could repeat the massive stimulus seen in 2009 to stave off another slowdown.

Negative scenario—The euro zone breaks up
Low probability; Very high impact; Risk intensity = 10 The economic crisis has exposed serious weaknesses in the euro zone. First, highly indebted peripheral euro zone economies face painful adjustment processes to restore their competitiveness. Second, richer countries have had to sign up to huge bailouts of more profligate members. The resultant strains could lead to the break-up of the euro zone. This scenario would be hugely destabilising for the global economy. The weaker former members would default as their currencies plummeted and funding costs soared. Banks globally would be severely shaken. The US dollar would shoot up, choking off the US recovery and also hitting countries with currencies tied to the dollar, notably China.

Negative scenario—Economic upheaval leads to widespread social and political unrest
Moderate probability; Moderate impact; Risk intensity = 9 The global economic downturn is having a severe social impact. Outbreaks of violent protest since its onset have so far been limited. However, given higher unemployment and poverty, weak growth, fiscal austerity measures and a rise in food prices, protests could yet increase in frequency and intensity. In some cases, this could bring the survival of governments into question. The risk is that instability becomes systemic, with political crises in certain countries affecting others through contagion or through the actions of populist new regimes seeking to assert themselves. Widespread social and political unrest would carry a considerable economic and financial cost.

Negative scenario—High inflation forces fiercer policy tightening in emerging markets
Moderate probability; Moderate impact; Risk intensity = 9 While the developed world continues to contend with the threat of deflation, inflation is a growing concern in many emerging markets. Inflationary pressures are being driven by policy stimulus, capital inflows and rising food and

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commodity prices, as well as by reluctance to allow currencies to appreciate. Central banks in the emerging world have generally been reluctant to raise interest rates for fear of encouraging further capital inflows, but this will not be sustainable if core inflation rises substantially. Monetary policy looks to be behind the curve in some countries. Rising inflation could force a sharper tightening of policy in emerging markets than we currently expect, which would hit growth.

Positive scenario—Confidence revives, prompting a stronger rebound in demand
Low probability; High impact; Risk intensity = 8 We continue to believe that risks to the global economy are concentrated on the downside. However, there remains some upside risk. If concerns weighing on sentiment, notably over the dangers of a double-dip recession, prove exaggerated, market confidence could surge again. With monetary conditions still loose, improved market sentiment could foster a stronger rebound in private demand, creating sufficient self-sustaining impetus in the private sector for robust growth to survive the withdrawal of stimulus measures. But this depends on an absence of further shocks, and we view this scenario as only a low probability.

World economy
A grand sort-of bargain
As widely expected, the G20 summit in Seoul has produced an in-principle commitment to reducing global economic imbalances, without setting concrete targets. The lack of enforceable specifics is likely to attract criticism, but a consensusdriven agreement has its merits and is probably the best that could have been expected in the circumstances. The agreement could give impetus to efforts to reduce current-account imbalances and address excessive capital flows to emerging markets. However, international tensions over trade, exchange rates and monetary policy are unlikely to evaporate as long as the economic fundamentals underpinning these problems persist. It was clear in the run-up to the summit on November 11th-12th 2010 that there were serious differences between key G20 members. The need to accommodate those differences has inevitably diluted the final agreement, resulting in a list of essentially aspirational targets. This also reflects a fundamental limitation: the G20 is little more than a loose grouping of large developed and emerging economies, lacking a defined institutional framework or formal authority. The summit's most noteworthy commitments, outlined in the now-obligatory communiqué, are those relating to exchangerate policies, capital flows and current-account balances. On currencies, G20 members collectively pledged to move "towards more market-determined exchange-rate systems"; to eschew (in the case of advanced economies) policies that could cause exchange-rate volatility or generate unduly large capital flows to emerging markets; and to avoid competitive currency devaluations. The first of these commitments seems to be a concession to the concerns of the US over China's exchange-rate policy. Although the renminbi has appreciated by about 25% against the US dollar since China loosened its currency peg in mid2005, the US maintains that the currency is still seriously undervalued, as evidenced by China's rising foreign-exchange reserves and large current-account surplus. However, the text of the communiqué does no more than assert the desirability of more market-oriented exchange-rate policies. This gives China latitude to adjust its currency regime at its own pace, albeit binding China informally to the principle of currency reform. Underlining the quid pro quo that informs the G20 agreement, the second of these commitments is patently a concession to emerging markets worried about the impact of US quantitative easing (QE) on their own currencies. Many emergingmarket currencies are under substantial upward pressure, and the communiqué in effect warns the US not to allow QE to debase the dollar. The document also gives a nod to related concerns that ultra-loose US monetary policy is encouraging large and destabilising capital flows into emerging markets. Crucially, it offers a barely disguised endorsement of the use of capital controls should inflows prove unmanageable, a position that could give the green light to stronger policy action by emerging-market policymakers.

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Given pre-summit expectations, the most anticipated part of the agreement was that concerning current-account imbalances. The US had advocated caps of 4% of GDP on current-account surpluses and deficits, but this plan faced opposition from China and Germany, among others, and was never likely to be adopted (even assuming that such targets would be practical, which is unlikely). Instead, G20 finance ministers and central bankers will establish indicative guidelines on current-account balances, with the aim of triggering a policy review if the indicative limits are breached. This looks like a fudge. Certainly, if guidelines are to be produced and reviewed next year as planned, they will have to provide ample leeway for both surplus and deficit countries to resist rapid rebalancing of their economies. As expected, the G20 summit also reiterated endorsement of financial regulatory reform under the auspices of the Basel III process, as well as reform of IMF voting rights to give emerging markets greater representation. But the limitations of the G20 format remain in evidence. The G20 has no mechanism for obliging countries to meet pledges and targets, and the token display of solidarity required to present the summit as a success may soon give way to renewed friction once politicians' focus returns to domestic economic challenges. This is the heart of the problem. In the early stages of the financial crisis, policymakers were pulling in similar directions because most economies were weakening. The synchronised nature of the crisis resulted in a synchronised policy response, in which many countries slashed interest rates and implemented fiscal stimulus. Now policy priorities are diverging, as many rich countries face renewed economic weakening while emerging markets continue to power ahead. The in-principle commitments are still useful, in that they can provide a framework for policy debate and exert a degree of moral pressure on governments. But the prospect of the G20 formulating policies that are both robust and acceptable to all of its members looks remote.

Regional summaries
North America: growth and inflation
(% change) 2006 US Real GDP growth Inflation Canada Real GDP growth Inflation
Source: Economist Intelligence Unit.

2007 1.9 2.9 2.2 2.1

2008 0.0 3.8 0.5 2.4

2009 -2.6 -0.3 -2.5 0.3

2010 2.7 1.5 2.7 1.6

2011 2.2 1.0 2.0 1.8

2012 2.1 1.9 2.3 2.0

2013 2.3 2.5 2.5 2.2

2014 2.2 2.8 2.6 2.2

2015 2.5 2.8 2.5 2.2

2.7 3.2 2.8 2.0

The US economy will be boosted by new stimulus measures

The Economist Intelligence Unit has raised its forecast for US GDP growth in 2011 to 2.2%, from 1.5% previously, in view of a fresh round of fiscal stimulus measures that are soon to be approved by Congress. The US economy has slowed in response to the withdrawal of fiscal stimulus and the end of the restocking cycle. As the effects of these boosts are fading, the structural weaknesses in the US economy are again being exposed. The US economy grew by a revised annualised 2.5% in the third quarter of 2010, which was up from an initial estimate of 2% and a marked improvement on the 1.7% expansion of the preceding quarter, but down from 3.7% in the first quarter of the year. Moreover, these rates of growth are far slower than is normal for this stage of an economic recovery and short of the pace that is needed to reduce the unemployment rate. There was a genuine risk that without the new stimulus, the private sector would have proved unable to take up the slack and growth would have slowed sharply. We still have concerns about the structural problems plaguing the US economy, and forecast muted growth in the medium term, but the government's plan should be enough to guard against recession.

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The core of the problem with the US economy is the high indebtedness of the household sector. Around one-quarter of home owners are trying to work their way out of negative equity, following the collapse in house prices. Many more are looking to reduce their debt to more normal levels. The housing market, which had showed signs of revival in late 2009, has weakened again following the expiry of temporary tax credits in April. The unusually large stock of unsold housing on the market (nine months of supply, compared with the four or five months seen in a healthy market) suggests that a vigorous recovery in house prices is unlikely during the forecast period. This means that balance-sheet repair will have to come from a prolonged period of spending restraint. In this climate firms are reluctant to invest, even though their cost of borrowing is low (and may fall further as the second round of quantitative easing is rolled out).
North America: US house prices
(Q1 2000 = 100)
200 190 180 170 160 150 140 130 120 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2003 04 05 06 07 08 09 10
Source: Case/Shiller home price index.

A lack of job creation is weighing on private consumption

Perhaps the most worrying aspect of the US economy at the moment is its inability to create jobs. In November 2010 the unemployment rate stood at 9.8%, well above the 5% average in the decade before the financial crisis. Moreover, many Americans have given up looking for employment. If the labour force had continued to grow at its pre-crisis trend rate, the unemployment rate would now be as high as 12%. Long-term unemployment is a concern. Almost one-half of the officially unemployed have already been out of work for at least six months. The decline of the construction and manufacturing sectors has created a pool of workers with unneeded skills, while problems in the housing market have led to a reduction in labour mobility, since many people cannot sell their homes and move to areas with better employment prospects. Together, these factors have raised the structural unemployment rate by around 1.5 percentage points, according to the IMF. Prospects for a rapid improvement in the employment situation are not encouraging. The economy needs to create around 150,000 jobs a month just to keep up with growth in the working-age population; it just about reached this target last October, but employment fell in each of the previous four months, and in November only 39,000 extra jobs were created. Moreover, with the federal and state governments trying to get their finances under control, it will be solely down to the private sector to create jobs. We expect that companies will remain reluctant to rebuild their payrolls rapidly, with the result that the rate of unemployment is forecast to remain above 9% in 2011.

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Persistently high unemployment will weigh heavily on GDP growth, given that private consumption represents over 70% of GDP. Real estate problems will not only weigh on household finances and limit labour mobility, they will also continue to hurt the banking sector. Not only are one-quarter of houses now worth less than the mortgages that were used to buy them, the persistently high unemployment rate has also undermined the ability of many home owners to service their debt. Government programmes that have been put in place to help restructure mortgages often provide a respite but not a full resolution. This means that there is still a large amount of housing likely to come into foreclosure, and many homes already held by banks as a result of foreclosures have not yet moved onto the market. The likelihood of foreclosures exerting further downward pressure on the assets quality of US banks will contribute to their reluctance to lend more aggressively.
Some additional fiscal stimulus measures are agreed

Between the second half of 2009 and the first half of 2010, the US recovery was driven by fiscal and monetary stimulus and by the end of destocking by companies. However, when fiscal support for the economy started to wane, autonomous private-sector demand proved too weak to generate a sufficient rate of job creation to bring down the unemployment rate. The administration has responded with a new package of stimulus measures that should soon be approved by Congress. In addition to extending all of the Bush-era tax cuts, the package includes a 2-percentage-point payroll tax reduction in 2011, a 100% tax deduction on purchases of businesses equipment and an extension of unemployment benefits for another 13 months. In total, the measures are worth about US$300bn (equivalent to around 2% of GDP), with most of the effect coming in 2011. The direct boost to the economy will be a good deal smaller. Part of the tax cuts will be saved, for example. Nevertheless, we have raised our GDP growth forecast for 2011 to 2.2%, from 1.5% previously, in response, and if the extra stimulus has the effect of boosting consumer and business confidence over the coming months, we could raise this forecast further. One risk is that investors are spooked by the government taking on additional debt without explaining how it intends to set its finances on a more sustainable path in the longer term. The president's bipartisan fiscal commission has suggested ideas for narrowing the budget deficit, but it could not reach a consensus on the correct approach. Moreover, the recent negotiations over the Bush tax cuts have shown how difficult it can be to raise taxes. Even though the payroll tax cut is only set to be in place for a year, it might be difficult, politically, to allow it to expire. Yields on US government debt have risen further since the announcement on fiscal stimulus. This development may predominantly reflect improved confidence in the economic outlook, but some investors may be worrying about the ability of the US government to service its debts.

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North America: US Treasury bond yields
(%)
4.2 4.0 3.8 3.6 3.4 3.2 3.0 2.8 2.6 2.4 2.2 Jul Aug Sep 2009

Oct

Nov Dec

Jan 10

Feb Mar

Apr

May Jun

Jul

Aug

Sep

Oct

Nov

Dec

Source: US Federal Reserve.

US economy
The Bush tax cuts—the easier compromise
On December 6th 2010 the US president, Barack Obama, and Republican leaders in Congress agreed to a two-year extension of all of the tax cuts under the previous administration of George W Bush, which included cuts in income, capital gains and estate taxes, as well as tax credits for childcare and education. The deal also includes a new round of stimulus measures. For now, then, austerity is being wisely put on the back-burner, but the recent failure of Mr Obama's fiscal commission to agree on a plan for reducing the budget deficit in the medium term is still disappointing. The uncertainty created by the absence of a credible medium-term budget plan could undermine the effect of the latest stimulus measures. Despite agreement among party leaders, Democratic and Republican caucuses still need to agree to the deal. A chorus of Democrats' complaints has resounded over the concession on tax cuts for the rich, but it appears that the agreement will be approved, possibly after some compromise on estate tax, which many Democrats feel has not been set high enough— estate tax will be increased from nothing in 2010 to 35% for individuals bequeathing more than US$5m in the next two years. At present it appears that the package is worth around US$900bn over two years, with US$300bn of this representing net stimulus (extending the Bush tax cuts merely avoids a tightening of fiscal policy, rather than an injection of new cash). The US$300bn will come from an extension of unemployment benefits, a 100% tax credit for spending on business equipment, and a one-year 2-percentage-point cut in Social Security payroll taxes paid by employees in 2011. The word stimulus has been carefully avoided by the Republicans and Democrats, but the agreement represents an acknowledgement by both sides that the economic recovery is in danger of stalling and needs a kick-start. Politically, the agreement on December 6th can be seen as a defeat for Mr Obama. The Republicans were in favour of extending all of the Bush tax cuts, arguing that no taxes should be increased at a time of economic weakness. The president wanted the income tax cuts to expire for the richest 2% of Americans, arguing that it was hard to justify creating a US$700m hole in the budget over ten years to put money in the pockets of America's richest people, who in any case tend to save a high proportion of their additional income. But the Republicans' strong position in Congress has helped them to carry their argument. Mr Obama, rather than risking the expiration of all the tax cuts, has agreed to an extension of them all. But Mr Obama has also drawn concessions from the Republicans, most notably the extension of unemployment benefits. The injection of more stimulus into the economy will help to reduce unemployment and boost his chances of re-election in 2012. This can therefore be viewed as a bipartisan agreement on fiscal policy, which is encouraging given the polarised nature of Congress. The Bush tax cuts were always going to be the first test of whether the Democrats and Republicans could work together, and that test appears to have been passed. However, this is a bipartisan agreement on

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how to spend borrowed money, with neither side having to concede anything too painful or contrary to their respective ideological stances.

Short-term stimulus achieved, long-term austerity in doubt
Where bipartisanship has been less apparent is over the question of how to deal with the long-term fiscal problem. It is right to inject some extra cash into the economy in the short term. Unemployment is stuck stubbornly above 9.5% and economic growth is well below the level that is normal for this stage of a recovery. The large output gap and steady decline of core inflation over the past year also mean that deflation is a genuine risk. The Federal Reserve (Fed, the central bank) has responded with more quantitative easing. Now the government has weighed in with some new support. The Economist Intelligence Unit has raised its GDP growth forecast for 2011 on the back of this decision. Obviously these measures will increase the budget deficit in 2011, which might anger fiscal hawks (so far the backlash has been muted). But the US government is currently under little pressure from financial markets. The yield on 10-year Treasuries stands at around 3.1%, which is up from the nadir of around 2% reached in late 2008, but is still historically low. US Treasuries are still seen as a safe haven, and the sovereign debt crisis in Europe is likely to ensure that investors retain their desire for security. But it would be a mistake to ignore the looming necessity of reining in the fiscal deficit. We estimate that the fiscal deficit will be equivalent to 8.9% of GDP in 2010. Previously we had expected the deficit to fall back to 7.3% of GDP in 2011, but the latest measures will mean there will be much less progress on reducing the deficit this year. The US cannot afford to keep borrowing at this rate, and the longer there remains a lack of clarity on how the government plans to bring its finances back onto a sustainable path, the more reluctant businesses will be to undertake new ventures and the less inclined households will be to start spending. Eventually there is even a danger that global financial markets will start to question the security of US Treasury bonds.

Facing the painful truth
Recognition of this looming problem led Mr Obama to task a bipartisan fiscal commission with drawing up a plan to reduce the budget deficit to 3% of GDP by 2015. In its final proposal the commission suggested a plan that would reduce the deficit to a more austere 2.3% of GDP. However, only 11 of the 18 members voted in its favour, which was fewer than the 14 needed to present it to Congress. Of that 11, at least two would not have voted in favour if the vote had been taken in Congress. They instead viewed the plan as a good starting point for debate. The substance of the final recommendations was generally good. Most importantly, the commission did not shy away from putting sacred cows on the block. Republicans are usually fiercely opposed to cuts in security spending, as they demonstrated in their "Pledge to America" ahead of the mid-term elections. The commission subjected security spending, which accounts for two-thirds of discretionary spending, to the same growth caps as non-security discretionary spending. It also suggested ideas for putting the cost of entitlement programmes like Social Security and Medicare, which are set to balloon as the population ages, on a more affordable track. Cuts to entitlements will be hard to stomach for Democrats. Nancy Pelosi, the outgoing speaker of the House of Representatives, has already said she could not accept this plan. The commission also took the axe to "tax expenditures"—tax breaks that tend to favour special interest groups and are worth around US$1.1trn a year. These would be reduced drastically, which would make the economy more efficient by removing distortions of economic incentives and free up funds for an across-the-board reduction in taxes. According to the commission, if all tax expenditures are removed, the top individual income tax rate could be reduced from 35% to 23% and the top corporate rate from 35% to 26%, and there would still be US$80bn a year left over in savings. Neither party would be too sorry to see tax expenditures reduced, but special interest groups will put up a bitter fight. It is important that these necessary and difficult decisions are now being discussed, but whether or not sufficient political will exists to reach an agreement remains the key question. That is why the lukewarm support from within the commission was disappointing. The true test of whether Congress can compromise for the good of the economy is yet to come.

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The Fed is embarking on a second round of QE

Monetary policy has also provided massive support for the economy, as the Fed has cut interest rates and made ample use of unorthodox measures (quantitative easing, or QE). The Fed announced in early November 2010 that it would pursue another round of QE, purchasing around US$600bn of US Treasuries by mid-2011. This should push down long-term interest rates and lend support to the economy. The efficacy of further QE has been a matter of debate within the Fed, and there are also concerns about its ability to withdraw the liquidity that it has pumped into the financial system once the economy starts to recover and inflationary pressures return. Meanwhile, the target for the federal funds rate is still a band of 0-0.25%. The Fed continues to indicate that it will keep interest rates at exceptionally low levels for an "extended period". Given the normal relationship between interest rates, inflation and the output gap, we do not forecast a rate hike until the second half of 2012. Recent price movements, however, suggest that inflationary pressures remain muted, with core inflation below 1% year on year and demand for credit depressed. The US economy will remain subdued in 2012-15, with annual average GDP growth of 2.3%. This will be much lower than the annual average rate of 3.2% in the 1990s and also weaker than the pace of 2.7% during the last decade up to the start of the crisis in 2007. This reflects the fact that investment in productive capacity will remain on a weaker trajectory than before the crisis and that households, banks and the government will have to continue the process of rebuilding their balance sheets for some time. Also, a shift to a more exportoriented economic structure would initially require painful structural adjustment. Labour force growth is likely to weaken, and this is unlikely to be offset by productivity growth. Although the Canadian economy contracted slightly more than that of the US during the recession, Canada's fundamentals are much healthier than those of its southern neighbour. Most importantly, the financial sector is stronger, which has meant that households have been able to benefit from very low interest rates, with the result that house purchases have also surged. Interest rates have, however, started to rise and the government is taking measures to contain the housing boom, but this will only partly offset the positive impact from a strong financial sector. Also, the government finances are in good shape structurally, despite a marked deterioration in 2009. Nevertheless, Canada's high exposure to the US means that it would inevitably be affected if, as we expect, the US economy slows in 2011. The risk of the Canadian economy slipping back into recession is minimal, but we expect a slowdown in GDP growth to 2% in 2011, from 2.7% in 2010. A reasonable recovery is expected in 2012-15, with GDP growth averaging 2.5% a year.

Some momentum will be regained in the medium term

Canada’s fundamentals are relatively sound

Japan: growth and inflation
(% change) Real GDP growth Inflation
Source: Economist Intelligence Unit.

2006 2.0 0.2

2007 2.3 0.1

2008 -1.2 1.4

2009 -5.3 -1.4

2010 3.5 -0.9

2011 1.2 0.1

2012 1.3 1.0

2013 1.1 1.0

2014 1.2 0.9

2015 1.2 1.5

Japan's policymakers are moving to support the recovery

Japan was one of the fastest growing of the major economies in 2010, having expanded by an estimated 3.5%. Proximity to China’s booming economy has
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given Japan a big advantage in its attempts to generate GDP growth, contributing heavily to the rebound in its exports, which are estimated to have expanded by over 25% in 2010. Such a robust rebound should not, however, mask the difficulties for Japanese policymakers of achieving a self-sustaining recovery in domestic demand. The government, led by Naoto Kan of the Democratic Party of Japan (DPJ), has passed a new stimulus package, worth around ¥5.1trn (US$60bn), to parliament. At around 1% of GDP, this will boost economic growth, but it will not be enough to counteract the headwinds that the economy faces in 2011, most notably an expected slowdown in exports as demand from its major markets cools. Worryingly, the economy is still battling with deflation, which makes it extremely difficult to stimulate the economy using monetary policy. The Bank of Japan (BOJ, the central bank) has lowered its short-term interest rate to virtually zero and has begun a programme that will see it purchase ¥5trn (US$60bn) of assets, including government debt, commercial paper, corporate bonds, exchange-traded funds and real estate investment trusts. This quantitative easing programme, a fraction of the one in the US, is likely to be too small to have a significant effect on long-term interest rates, and deflation, in any case, limits the extent to which the BOJ can push down real interest rates. The BOJ has also tried to ease the pressure created by currency appreciation. The yen has been on an appreciating trend since 2007 and strengthened by around 12% against the US dollar in 2010. This has undermined the competitiveness of Japanese exporters even if Japan's deflation means that the real exchange rate has not appreciated as much as the movement in the nominal exchange rate would suggest. In mid-September last year the BOJ intervened to weaken the yen, but the ineffectiveness of the move in the face of market forces means that it is unlikely to do so again in the near future. Japanese exporters will continue to gain some relief from being positioned in the fastest-growing region in the world. We maintain our forecast that Japan's real GDP will expand by just 1.2% in 2011 and 1.3% in 2012, reflecting the constraints imposed by a declining population, increasingly limited fiscal flexibility and weakening demand for Japanese exports. Like their US peers, Japanese firms have seen a sharp rise in profitability on the back of cost cutting. This is being reflected in an improvement in corporate confidence. In its September Tankan survey of corporate sentiment, the BOJ reported that conditions in the manufacturing sector had improved and that firms are estimated to increase investment spending by 3.7% in 2010. But an increasing number of firms are becoming pessimistic about future prospects. Most firms still believe that they have excess employment and capacity, although fewer than in the June survey. Moreover, consumer confidence declined in each of the four months to October, which will further dampen the willingness of Japanese firms to invest in new capacity. Labour market conditions are tentatively encouraging. Wages (for companies with five employees or more) were up by 0.6% year on year in October 2010. Although most of the recent increases were made up of increased payments for overtime and bonus payments, scheduled earnings also increased by 0.1% year on year. This increase, while small in size, was significant in being the first in

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Global outlook

more than two years. Nevertheless, consumer spending power would quickly suffer if the economy were to slow again, forcing companies to cut overtime and bonus payments. Demographic factors will continue to weigh on Japan's economic growth rate in 2011-15, given that the ageing of the population is set to accelerate. Increasing numbers of the baby boom generation (who were born in the years following the second world war) are now retiring. Low birth rates in more recent years mean that fewer youngsters will be entering the workforce, while persistent hostility in Japan towards immigration means that there will be no large-scale inward migration to swell worker numbers. This will ensure that the population will shrink steadily, by 0.3% a year, in 2011-15 and that the workforce will contract by around 1% a year over the same period. Given these unfavourable demographic factors, Japan's disorderly public finances, and persistent deflationary pressures, we expect the economy to be stuck in the slow lane, with GDP growth forecast to average 1.2% a year in 2011-15. Japan’s consumer prices fell by an estimated 0.9% on average in 2010. The above-trend GDP growth notched up in 2010 should, however, help to narrow the output gap, thus exerting upward pressure on prices, albeit with a lag of around three to four quarters. Accordingly, we forecast a slight rise in consumer prices in 2011, on the assumption that there is no sharp slide in prices for oil and other commodities. The easing of deflation will allow the BOJ to raise its policy rate, the overnight call rate (OCR), to 0.25% in the second half of 2012. Tightening over the remainder of the forecast period will, however, be slow, with the OCR forecast to rise to only 1.75% by 2015.
A fiscal crisis in the short term is unlikely

Japan's already dire public finances will continue to deteriorate. On the basis of our forecast of a primary budget deficit of 3.3% in 2015, the government has no prospect of making inroads into its large stock of public debt during the forecast period. Mr Kan has pledged to restore Japan’s primary budget to balance by fiscal year 2020/21 (April-March)—simply to start making inroads into the debt stock, however, will require Japan also to register chunky primary budget surpluses. We forecast that the gross public debt stock will rise to 207% of GDP by end-2015, by far the highest level in the developed world. The fiscal crisis in the euro area has raised the risk of tensions in Japanese bond markets, although this is not part of our main scenario, largely because much of the Japanese government’s debt is held domestically and much of this is held by the public sector. The poor showing of the DPJ in the election to the upper house (the House of Councillors) in July 2010, its consequent failure to secure a majority in the chamber and, latterly, Mr Kan's increasing lack of authority within the party, all augur ill for aggressive fiscal reform over the forecast period. Although there is widespread agreement among Japan’s political parties about the need to rehabilitate the public finances, there is less unanimity on timing. The need to secure the agreement of smaller parties in the upper house to pass bills thus raises the risk of policy paralysis, and progress on policy enactment will probably happen on a policy by policy basis. The next general election is not due until August 2013, but policy stasis could force the government to call an election as soon as early 2011.

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Western Europe: growth and inflation
(% change) 2006 GDP growth Euro area EU27 EU15 New membersa Consumer price inflation Euro area EU27 EU15 New membersa
Source: Economist Intelligence Unit.

2007 2.8 3.0 2.7 6.2 2.1 2.4 2.1 4.1

2008 0.4 0.5 0.2 4.0 3.1 3.4 3.2 6.1

2009 -4.1 -4.2 -4.3 -3.6 0.2 0.7 0.6 3.1

2010 1.6 1.5 1.7 1.6 1.3 1.8 1.7 2.8

2011 0.9 1.0 1.0 2.9 1.2 1.7 1.6 2.7

2012 1.3 1.6 1.4 3.4 1.5 1.7 1.7 2.6

2013 1.6 1.7 1.6 3.5 1.6 1.9 1.9 2.4

2014 1.9 1.9 1.9 3.6 1.7 2.0 2.0 2.3

2015 2.0 1.7 1.9 3.5 1.9 2.1 2.1 2.4

3.1 3.3 3.1 6.5 2.0 2.2 2.1 3.1

a Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia (excluding Malta).

The euro zone is in the worst crisis since its inception in 1999. Large debt burdens and macroeconomic imbalances within the euro zone have caused the markets to lose confidence in the solvency of peripheral euro zone sovereigns and even in the very viability of the single currency. Policymakers belatedly responded to disorderly market conditions by agreeing a €110bn (US$138bn) bailout of Greece in April 2010. This was followed by the announcement on May 10th of joint EU and IMF financing totalling €750bn, including €440bn from the European Financial Stability Facility (EFSF), a new financing vehicle guaranteed by euro zone members. At the same time as the EU-IMF financing was announced, the European Central Bank (ECB, the euro zone's central bank) launched a programme of buying government bonds to restore liquidity in the bond markets of peripheral euro zone member states. Then, in July the EU announced the results of stress tests conducted on its largest banks, which all but five institutions passed.
Ireland accepts a €85bn EU-IMF loan

These policy initiatives appeared to have some success initially but have ultimately failed to restore confidence. Greek government bond yields have remained high, pricing the sovereign out of funding markets, and in November last year Ireland was forced to apply for financial assistance from the EU and IMF. This followed a relentless rise in Irish bond spreads since September as investors became increasingly alarmed at the government's contingent liabilities to the banking sector. In November it emerged that estimates of the cost of bailing out Anglo Irish and Irish Nationwide Building Society had risen to €40bn. This will have pushed up Ireland's fiscal deficit to around 38.5% of GDP in 2010, while public debt is expected to spike sharply from 65.8% of GDP at end-2009 to around 126% of GDP by end-2011 and 138% of GDP by 2014.

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Western Europe: Euro zone bond yields, 2010
(%)
Greece 14.0 12.0 10.0 8.0 6.0 4.0 2.0 Jun Jul Aug Sep Oct Nov Dec Ireland Italy Portugal Spain

Source: Economist Intelligence Unit.

The Irish government had been reluctant to apply for assistance. It did not have to tap the market for funds until mid-2011 (although its banks have been dependent on ECB liquidity facilities to meet their large rollover needs). But as the crisis escalated, EU policymakers prevailed on the government to seek financial assistance, worried that if it did not the pressures on other euro zone countries, such as Portugal and Spain, would become unbearable. Under the €85bn EU-IMF financing deal, Ireland will have to introduce further austerity measures and channel funds into recapitalising and slimming down the financial system. The overall cost of the funding is estimated at 5.5%. This is higher than the 5% cost faced by Greece but less than had been feared
Portugal is expected to receive EU-IMF financing

We do not expect the Irish loan deal to prevent Portugal from needing financial assistance sometime early this year. In the case of Portugal, investor concerns centre on the government's solvency given the combination of a large fiscal deficit and modest growth prospects. Provided Portugal is the only other euro zone member to require assistance, the current financing arrangements will be sufficient. But if Spain—a much larger country than Greece, Ireland or Portugal— also requires help, the EU will have to increase the funding available (or the ECB will have to start buying large amounts of euro zone government debt). Until the escalation of the Irish crisis, Spain had succeeded in recent months in quelling concerns over its solvency, owing to the government’s announcement of austerity measures to rein in the fiscal deficit and steps to consolidate and cleanse the troubled savings bank sector (cajas de ahorros), which faces large asset impairments because of its exposure to Spain's deflating property market. Even if the Irish financing package is successful in restoring order to euro zone government debt markets, restoring solvency and addressing imbalances within the euro zone will remain long-term challenges. At present, there are few signs that politicians or electorates are prepared to undertake the reforms necessary to consolidate the euro zone in a structural fashion, such as the introduction of fiscal transfers between stronger and weaker states.

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We assume that no member of the single currency will leave. Whatever the pain of adjustment (a protracted period of falling wages and living standards), this would be outweighed by the high costs of leaving the euro zone (widespread bankruptcy and insolvency, and the loss of savings). Rather than weak peripheral countries leaving the euro zone, another possible outcome would be for Germany and other strong countries to leave. This might prove less catastrophic financially than forced exits by weak members, but it would still create potentially catastrophic instability in financial markets. In 2011 fiscal tightening will be a drag on growth across the euro zone. This will be most marked in stressed peripheral countries (Greece, Portugal, Ireland, Spain and Italy), which are under pressure to reduce their deficits quickly. But other countries will also seek to reduce their deficits faster than previously thought. The German government, for example, has abandoned earlier proposals for tax reductions planned for 2011 and instead announced fiscal consolidation measures worth €80bn over the next four years, including cuts in public-sector pay and a reduction in public payrolls. France is also taking measures to rein in its deficit.
GDP growth in the region in the second quarter of 2010 was strong

Despite the debt crisis, the euro zone is posting a decent recovery from the recession. Having grown by 0.3% quarter on quarter in the first quarter of 2010, euro zone GDP is estimated to have expanded by 1% in the second quarter and by 0.4% in the third quarter. The recovery is being led by Germany, which grew by 2.2% (almost 9% annualised) in the second quarter as German manufacturers benefited from buoyant demand—particularly for capital goods—in emerging markets. Greece and Ireland were the only countries to contract, dragged down by fiscal austerity, a loss of confidence and high borrowing costs. France and Italy, the second- and third-largest economies, grew by 0.7% and 0.5% respectively, better than expected. Spain and Portugal, two of the distressed peripheral economies, both posted growth, but only by 0.2% and 0.3%, respectively. The pace of growth slowed in the third-quarter data. This was to be expected as impetus from stockbuilding and stimulus faded. Germany grew by 0.7%, still a reasonable pace. Encouragingly, there are signs of a revival in domestic demand. France slowed to 0.4%, while Italy slowed to 0.2%. As yet there are no signs that the disorder in peripheral euro zone bond markets is having an adverse impact on confidence across the euro zone. Nevertheless, in 2011 we forecast a pronounced slowdown in economic growth to 0.9% for the euro zone as a whole, followed by a pick-up to 1.3% in 2012. Thereafter we expect a steady acceleration in the pace of growth, to 2% by 2015. As well as restoring solvency, the region faces the challenge of managing imbalances within the euro zone. The data in the first nine months of 2010 confirm the picture of a two-track euro zone. Export-oriented countries, such as Germany and the Netherlands, are performing well, benefiting from buoyant emerging-market demand. In contrast, the peripheral countries are struggling. In addition to the headwinds from fiscal austerity and rising financing costs, these countries (Greece, Portugal and Spain) lack strong export bases. Rigid labour markets and private-sector wages are also obstacles to these countries restoring their competitiveness.

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The euro zone
Is a break-up on the cards?
The euro area sovereign debt crisis is threatening to escalate at a frightening pace, as liquidity and solvency concerns continue to weigh on peripheral member states. There is a risk that if Europe's policymakers do not act sufficiently quickly, contagion could spread to the region's larger economies, adding to financing pressures and raising fears over the stability of the European banking system. The Economist Intelligence Unit's central forecast is that Portugal will have to follow Ireland and Greece in requesting emergency EU-IMF funding, but that Spain will not and that the euro area will continue to hold together. However, the mammoth challenges that lie ahead in terms of countries implementing painful fiscal austerity and agreeing a euro-wide consensus on radical institutional reform point to a period fraught with risk. This article explores a number of scenarios whereby the current turmoil could ultimately lead to a break-up of the euro area, and examines some of the myriad of implications that this could bring. Greece and now Ireland are on external financial life support, enduring an open-ended period of painful fiscal austerity with no guarantee that either economy will return to a position—in the absence of additional external support and/or some form of debt restructuring—in which it is able to meet its huge debt-servicing commitments. This is the reality now facing two of the euro area's peripheral economies, with doubts also persisting in the markets over the ability of other economies in the region to generate sufficient nominal growth to sustain their mounting private and public debt piles. Teetering sovereigns such as Ireland's are the outcome of policy responses adopted in response to the global debt crisis that triggered the financial turmoil in 2008, and it is possible that other countries could in time face similar problems (Greece is actually an outlier in this regard, in that the root cause of its fiscal problems lies in the unsustainable— and, until recently, hidden—debt accumulation of its public sector, rather than its private sector). It can come as little surprise that the process of governments transferring substantial losses from private-sector bank balance sheets to sovereign balance sheets (and thus taxpayers) has resulted in a global banking crisis morphing steadily into a sovereign debt crisis. The financial markets now recognise that Greece and Ireland face both serious short-term liquidity and medium-term solvency risks. This implies that the current situation in the euro area in terms of its governance structures, fiscal framework and policy stance cannot continue ad infinitum, and will have to change quite radically, as Germany has recognised in its recent call (however poorly timed) for wider burden-sharing as part of a permanent crisis resolution mechanism and its demands for increased fiscal discipline from all member states. There is a clear risk that if policymakers do not act sufficiently, the present turmoil in the region's periphery could continue to escalate and infect other larger economies, sending the crisis spiralling rapidly out of control. As an initial step, policymakers may have to move rapidly to ease investors' concerns over whether the official support mechanisms currently in place—quoted as totalling €750bn, but likely to be somewhat less—are of a sufficient scale to meet fully the estimated financing needs of the euro area's peripheral states during its scheduled lifetime up to mid-2013, particularly if further bank recapitalisations are needed and/or if Spain were to require emergency funding. The proposed bailout fund for Ireland is likely to total around €100bn of the funds currently available (the €110bn EU-IMF bailout for Greece is an entirely separate package). While our central forecast is that Spain will not need to seek assistance, it may still be necessary to convince the markets that sufficient funds would be made available in the event that Spain did encounter funding difficulties. This could require a substantial increase in the size of the support facilities. For the period beyond 2013, in acknowledgment of moral hazard concerns and the political challenges in creditor countries of standing behind an open-ended financial commitment, the euro area (on the initiative of Germany) will seek to put in place a permanent mechanism to provide finance for countries deemed solvent but unable to raise finance on the markets, and a debt restructuring mechanism for any countries deemed to be insolvent. Such a mechanism is likely to include two essential elements. First, procedures for opening and conducting negotiations between a sovereign debtor with unsustainable debt and its creditors, as well as rules for reaching agreement (so that a minority of bondholders cannot

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prevent a settlement being reached). Second, a financial facility for advancing loans to countries at risk of or having already defaulted, with strict policy conditions attached. Discussions are ongoing and such a mechanism will probably have to involve a treaty change so as to prevent Germany's contribution from being questioned or even banned by the country's constitutional court. Passing a treaty change in all member states will be a lengthy process, and fraught with political risks in the countries that will provide support, as well as those that are likely to need it. Policy conditions would have to be both tough and implemented to the letter—if weak countries were to fail to correct their fiscal imbalances, creditor countries would tire of providing open-ended transfers. Given the difficulty that European policymakers have faced over the past six months in trying to contain market anxieties over the unfolding sovereign debt crisis, the euro area faces a huge challenge in trying to navigate its way to implementing these institutional changes, while also avoiding any slip-ups that could conceivably trigger another major banking crisis. Such is the scale of the challenge that some investors will now be focusing their attention a little more closely on what could lie ahead for the euro area and whether a possible "endgame" could involve a break-up of the euro area. Such an outcome is not inevitable, and nor is it our central forecast, but it is an appreciable risk. The remainder of this article explores how it might occur and what the implications might be. In theory, the euro area could break up in any number of ways, although the two most likely scenarios would seem to be that either one (or more) of the weakest economies elects to leave or that Germany (as the largest and most powerful economy in the region) decides it is no longer in its national interest to remain a member of the single currency. We will consider each of these potential risk scenarios in turn.

A peripheral departure?
It is possible that the economies of one or more of Greece, Ireland, Portugal and Spain continue to contract over a period of five years or more (in the case of Greece, Ireland or Spain this would mean for another two to three years from 2011), as a result of a combination of lack of competitiveness, capital flight and the deflationary impact of servicing public and private debt at a time of a harsh domestic fiscal austerity. Under this scenario, by 2013-14 the country would still be running a substantial deficit well above the "target" of 3% of GDP and, in order to secure continued external financing, would be faced with implementing public spending cuts and tax rises for the fifth or more year in succession. Such circumstances would be met with ever-increasing public disenchantment with mainstream political parties, leading the authorities at some stage to question their past assumptions on how to run the economy (the less popular and stable a government becomes, the more likely it is to resort to short-term solutions). This could include a reassessment of the country's membership of the euro and support for free movement of capital, leading to a decision to revert to a national currency in the hope of creating the conditions for future economic growth. If the country has already defaulted, the benefits of exiting the euro may be greater still. It is important to stress that leaving the euro would be no easy option, either for the country (or countries) concerned or its regional partners. The liabilities of banks, including bank deposits, are in euros and could not be changed into the country's new currency, except with the depositor or lender's consent, without undermining the basic contract between depositor and bank. However, bank assets in domestic shares or property would effectively now be in the new currency. Banks would have the right to insist that loans be repaid according to their value in euros, but to do so would probably lead to a large proportion of the loans becoming unrepayable. In practice, banks might therefore decide to make arrangements that take account of the new currency. Either way, the banks would incur losses that could lead to them requiring further recapitalisation and state support to address solvency concerns. Government debt would remain denominated in euros, unless changed by agreement or by unilateral action. It is possible that the country concerned may already have tried to negotiate a reduction of its sovereign debt. Given the inevitable depreciation of the new currency against the euro and so the reduced income base on which to service the debt, it would almost certainly be impossible to avoid negotiating such a "haircut" after leaving the euro, and this might well take the form

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of converting the debt into the domestic currency. But since the government would have to intervene to help banks, this would probably not be sufficient to bring sovereign debt under control. A likely consequence would be that the country's new central bank would be asked to monetise government debt. As a result of the impact of a falling currency on import prices and a highly accommodative monetary policy, inflation would probably be at least in double figures and possibly much higher during the first few years of the new currency. This would apply particularly to smaller countries such as Greece, Ireland and Portugal, which import a high proportion of their goods and services. To prevent a cycle of currency depreciation and inflation spiralling out of control, it is likely that capital controls would be necessary. According to conventional economic theory, variable exchange rates should be sufficient over time to restore the competitiveness of countries that have lost considerable ground since the formation of the euro area because of high wage growth and low productivity increases. (There are occasions when leaving a fixed currency link has facilitated a country's ability to return to growth, such as Argentina a decade ago and the UK after leaving the ERM in 1992.) This adjustment may not happen automatically, however. First there will be an inflationary spiral that can only be broken by the acceptance by unions of nominal wage increases well below inflation. Even if wage costs are lowered in relation to the core euro area countries, the extent to which an economy can benefit through higher exports or import substitution will depend on competitive conditions within particular sectors. In many areas, wages are still likely to be higher than in competing countries, such as China or, closer to home, Turkey or Morocco. If there was no major boost to exports from the competitive gains made from leaving the euro area, such gains could only come from import substitution. A weaker currency would facilitate this, but might not in itself make a dramatic difference. There is also a risk that this could lead to increasing protectionist pressures, which could call into question that country's continued membership of the EU. The decision of one country to leave the euro would not necessarily prompt others to do so. However, if after a period of time it became evident that departing the single currency was bringing more benefits than costs, other countries might follow suit. If Spain left, for example, then Italy might think of doing so. That would still leave a core of Germany, France, Austria and Benelux, although it is then possible that France would feel itself locked into an exchange rate that made it uncompetitive. If France ultimately decided to leave, that would mark the effective end of the euro area.

A core exit?
It is also possible that Germany may decide unilaterally to leave the euro. Again, there are competing arguments for and against such an outcome. In terms of the latter, German politicians are well aware that the previous generation when Helmut Kohl was chancellor entered into a serious long-term commitment to the single currency with its partners, especially France, and that this was an unspoken condition for support for German reunification. Moreover, Mr Kohl's policy was a continuation of those aimed at rehabilitating Germany after the second world war and integrate it in the EU and the West. Looked at from the situation today, German politicians of all colours consider the EU—and also the euro as an integral part of the Union—as providing the conditions for democratic stability and prosperity in the region. They are also aware that Germany's influence in today's world can be greater through the EU than by acting on its own. Finally, Germany benefits economically from having easy access to markets within a single currency area. Countering these arguments is the unpopularity of the euro among the German electorate, rising public opposition to "bailing out" weaker states, and the increasing difficulty of shaping the single currency along the lines initially envisaged by Germany, based on fiscal and monetary discipline. If the currency union appeared to be evolving into something very different, the impact might be to weaken Germany's commitment. This could happen in a number of ways. First, simply by the euro depreciating severely in the foreign-exchange markets and so becoming a fundamentally weak currency. A second factor could be the ongoing failure of many member states to address their fiscal imbalances over a long period. A third trigger could be if the European Central Bank (ECB) decided to go down the path of quantitative easing on a substantial scale, for example by buying large amounts of sovereign debt of the weaker economies (the president of the Bundesbank, Axel Weber—now a leading contender to become the next ECB president—has already voiced his opposition to the limited

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measures of this kind so far taken). A fourth factor might be that Germany's attempt to bring about a treaty change to set up a permanent crisis resolution mechanism is not ratified by any one of the member states and so cannot come into force. A combination of more than one of the above developments would probably be required significantly to weaken German commitment. However, a failure to ratify a treaty amendment could result in the constitutional court declaring that continuing financial support to weaker member states was illegal and this could hasten the departure of other member states. In any event, a limitation to the costs to the German taxpayer will remain a significant qualification to its commitment to the euro. Economically, Germany and other countries with close ties would suffer seriously from a German withdrawal or the full break-up of the euro area through other means. The new German currency would rapidly strengthen in the foreignexchange markets, which would adversely affect some German exports. Internally, import costs would fall, which would be likely to lead to deflation (falling prices) over several years, threatening the ability of debtors to repay their debts. If Germany left the euro, some or all the other countries might decide to continue with their own euro. They would benefit from gaining a substantial competitive advantage vis-à-vis Germany. But with their currency or currencies becoming weaker and the Bundesbank no longer an influence on monetary policy, inflation would increase, possibly sharply. As stated earlier, neither of the scenarios discussed above reflect our central forecast. Perhaps the only thing that can be stated with any certainty at this point, with the sovereign debt crisis in the region showing little sign of easing, is that the period ahead remains fraught with risk. The new UK government focuses on fiscal consolidation

The UK emerged from its recession in the fourth quarter of 2009, later than other major economies, and growth prospects remain uncertain. This reflects the importance in the economy of the overextended financial sector, the aftereffects of an earlier decline in house prices, and weak demand in the important euro zone export market. Following the change in government in May 2010, the coalition announced a five-year programme of drastic fiscal tightening, with the dual budgetary aims of eliminating the large structural hole in the public finances and placing the public debt burden on a declining path within the next five years. Although fiscal tightening is required to restore confidence in the UK economy, the plan will have a negative impact on growth in the short term and could push the economy back into recession. UK GDP contracted by 5% in 2009, the first full-year contraction since the early 1990s and the worst since the second world war. After a sluggish exit from recession in late 2009, GDP is estimated to have risen strongly in the second and third quarters of 2010, driven by a surge in construction, solid manufacturing growth and government spending. However, the temporary nature of some of these factors underpins our forecast of a marked deceleration in the pace of expansion in late 2010 and into 2011. Given fiscal consolidation and continued balance-sheet adjustment by the household and financial sectors, we expect only modest growth in the medium term. The Bank of England (BOE, the central bank) halted its huge programme of quantitative easing in February 2010, having reached its £200bn (US$310bn) limit. Fears that the end of the asset purchase scheme would trigger a surge in bond yields have proved unfounded—despite high levels of issuance and persistent above-target inflation, yields on ten-year gilts were just above 3% in mid-November. Given the weak fundamentals of the UK economy, we expect the BOE not to begin to raise interest rates until the second half of 2012. BOE officials have been speaking publicly in support of a resumption of quantitative

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easing despite the fact that inflation remains above the bank's 2% target. Although the case for further QE is not convincing—official statements imply sharply differing views within the BOE as to the most appropriate policy stance—our forecast is that the bank will move to provide additional support to the economy through its only remaining policy tool and resume its QE programme in the first half of 2011.
Transition economies: growth and inflation
(% change) 2006 GDP growth Transition economies East-central Europea Balkansb Balticsc CISd Consumer price inflation Transition economies East-central Europea Balkansb Balticsc CISd 7.5 6.3 6.5 9.8 8.6 7.1 3.1 6.9 4.7 9.6 2007 7.6 6.0 6.0 9.1 8.8 7.8 4.0 8.0 7.2 9.8 2008 4.5 4.4 5.7 -1.2 5.0 11.8 5.9 8.9 12.1 15.7 2009 -5.6 -2.5 -5.9 -15.5 -7.3 8.1 3.3 4.8 3.1 11.7 2010 3.0 2.1 -1.0 0.0 4.3 5.5 3.1 4.5 0.7 7.3 2011 3.5 2.9 2.1 3.0 4.1 6.1 3.2 4.5 2.1 8.2 2012 3.9 3.4 3.7 3.2 4.4 5.3 2.7 3.5 2.2 7.2 2013 4.1 3.5 4.1 3.5 4.6 4.9 2.4 3.2 2.7 6.6 2014 4.1 3.7 4.4 3.8 4.5 4.6 2.6 2.9 3.0 6.1 2015 4.0 3.7 4.3 4.1 4.4 4.5 2.6 3.0 3.0 6.0

a Czech Republic, Hungary, Poland, Slovakia and Slovenia. All members of the EU. Slovenia is a member of the euro zone; Slovakia joined the euro zone in January 2009. b Bulgaria, Croatia, Romania and Serbia. Bulgaria and Romania are members of the EU. c Estonia, Lithuania, Latvia. All members of the EU. d Azerbaijan, Kazakhstan, Russia and Ukraine.
Source: Economist Intelligence Unit.

Eastern Europe will lag other emerging regions' growth rates

Eastern Europe is recovering, with exports and industrial output rebounding. However, business and consumer sentiment in the region is fragile, and its currency and bond markets are vulnerable to contagion from problems in the euro zone or a rise in risk aversion more broadly. Moreover, the recovery in a number of countries, particularly in the Balkans and the Baltic states, is lagging. The region as a whole has underperformed its emerging-market peers in 2010 and will continue to do so into the medium term. The sustainability of public debt will loom large, especially in the early years of our forecast period. The economic crisis revealed structural weaknesses in public finances, and budget deficits widened sharply, replacing previously large current-account deficits as the major source of vulnerability for many east European economies. Substantial fiscal consolidation will be required—this is now well under way, but might have to be accelerated if market sentiment towards the region sours. The marked improvement in current-account positions should, however, support external debt sustainability, while a number of countries continue to receive multilateral support. Only a moderate economic recovery is estimated to have taken place in 2010, with average growth of 3%. The recovery in the region is expected to strengthen thereafter, as progress is made in balance-sheet consolidation, although expansion, at 3.5% in 2011 and 3.9% in 2012, will be sluggish by pre-crisis standards. The pick-up in final demand in euro zone trade partners will be modest, and there is little prospect of a strong rebound in foreign direct investment and external bank loans. Credit conditions will be slow to relax, and

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private consumption will be constrained by still-high unemployment. As previously noted, in many countries fiscal tightening will be on the agenda as a means of restoring investor confidence in solvency. Concerns remain about the impact of the financial and economic crisis on medium-term growth potential.
Poland will remain firm, but Hungary is still vulnerable

Poland, which was an exception to the region's poor performance during the downturn, is estimated to have posted robust growth of 3.4% in 2010, and will remain one of the EU's stronger performers in 2011, growing by 3.8%. The country is less exposed to international trade than other countries in the region and, like the Czech Republic and Slovakia, less reliant on foreign borrowing. However, expansion will still be slow by pre-crisis standards, reflecting continued high unemployment and sluggish government spending. Slovakia is benefiting from the strong rebound in the automotive sector, which we estimate lifted growth to 4.2%, the highest in the EU, in 2010. Automotive sector trends are also helping the Czech Republic, but overall the country's recovery will be more sluggish owing to subdued prospects for its more diversified exports in its mainly west European markets. Hungary continues to face some of the greatest strains in the region because of its sizeable twin deficits (budget and current account) going into the crisis, and high foreign-currency debt exposure. The economy will again only post weak growth in 2011. The government has broken off talks on continuing the IMF stabilisation programme, and its plans to cut the budget deficit through a tax on banks and to suspend payments into private pension funds have aroused concerns. Although the government is likely to maintain a restrained budget deficit, its policies and decision to reject IMF assistance leave it vulnerable to shifts in market sentiment. Its hopes of striking a more favourable support deal with the EU look ill-founded, and it may yet have to turn back to the IMF.

The Balkans and Baltic states will be slow to recover

In the Baltics, Latvia is estimated to have seen a third and Lithuania a second year of contraction in 2010, although recovery has begun and both countries will grow in 2011. Estonia returned to growth in 2010. Risks remain to Latvia's currency peg. Our central forecast is that the Bank of Latvia (BoL, the central bank) will keep the lat within its current narrow band against the euro, supported by financing from the IMF and EU. Moreover, Latvia has made considerable progress on "internal devaluation", cutting wages and costs. Nevertheless, there remains a moderate risk that the authorities could opt for a currency devaluation if the recovery peters out. A lat devaluation would also cause Lithuania's currency peg to collapse, and would lead to widespread defaults of borrowers with unhedged foreign-exchange exposure in both countries. The EU has approved Estonia's entry to the euro zone in 2011, but wide fiscal deficits will rule out meeting the criteria for euro zone entry until at least 2014 for Lithuania and 2015 for Latvia, with a high chance of further delay. The Balkans contracted again, by an estimated 1%, in 2010. Continued external imbalances mean that a number of Balkan economies remain vulnerable to crises. The Balkan countries are also exposed to fallout from Greece's problems because of investment, trade, remittance and banking links. Romania faces tough austerity measures, and we estimate a contraction of 2% in 2010, followed by only a weak rebound in 2011. Resistance to cuts could create instability. Bulgaria is expected to have contracted marginally in 2010, but it will

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post a modest recovery in 2011. Its ability to respond to the crisis has been constrained by the lev's peg to the euro and the need to maintain a tight fiscal policy. We expect the currency board arrangement to be maintained.
Russia has returned to growth, but it will be below recent standards

Russia and Ukraine have both returned to growth in 2010, at an estimated 4% and 4.7% respectively. In Russia, growth has been dampened by the severe summer drought and wildfires, which affected the industrial, retail and other services sectors, as well as agriculture. But the government's large stimulus package, an upturn in external demand, and lower interest rates now that a degree of financial stabilisation has been achieved, have underpinned a robust performance. This will continue with growth of 4% in 2011, although, given structural problems, growth will remain below pre-downturn standards into the medium term. In Ukraine, domestic demand is benefiting from the greater stability prompted by the more settled political and policymaking environment under the new government, but growth will slow to 3.9% as steel prices fall.

Asia and Australasia (excl Japan): growth and inflation
(% change) Real GDP growth ASEAN China India Inflation ASEAN China India
Source: Economist Intelligence Unit.

2006 8.3 6.0 12.7 9.5 3.9 8.1 1.8 6.2

2007 9.3 6.6 14.2 9.6 4.9 5.6 4.8 6.4

2008 5.7 4.2 9.6 5.2 7.1 9.9 6.0 8.4

2009 4.9 1.1 9.1 7.7 2.8 2.5 -0.7 10.9

2010 8.1 7.4 10.2 8.8 5.0 4.5 3.2 11.9

2011 6.7 5.1 8.9 8.6 4.4 5.0 3.8 6.9

2012 6.8 5.6 8.6 8.8 4.4 4.8 3.7 5.1

2013 6.7 5.5 8.2 8.7 4.4 4.9 4.1 5.2

2014 6.6 5.5 8.0 8.6 4.4 5.0 4.0 5.9

2015 6.6 5.6 7.4 8.6 4.4 4.7 3.8 5.6

Asia will remain the world's fastestgrowing region

A strong recovery in industrial production and trade has been under way since the second quarter of 2009, and domestic demand has held up well in many countries. Historically, most Asian recoveries have relied on exports, while investments and private consumption have remained weak until well after the end of a recession. This time the situation is atypical. A recovery in exports as Western firms restocked was important, but the recovery in many countries has been driven by large fiscal stimulus packages and loose monetary conditions. The stimulus in China was the most important in absolute size and relative to GDP, but many other governments have implemented aggressive fiscal measures to support the economy. With fiscal stimulus now being withdrawn and monetary policy tightened across the region, the onus is again switching to autonomous private-sector demand. Third-quarter GDP data have been released by most countries, and with the exceptions of India and Hong Kong, all have shown a slowdown in year-on-year growth. Growth in Asia and Australasia (excluding Japan) is forecast to slow down to 6.7% in 2011, from an estimated 8.1% in 2010. Asia will remain the fastest-growing region in the years to 2015, although, with the exception of the bounceback year of 2010, growth rates will remain comfortably below the annual average of 8% recorded in 2005-07. That Asia will remain the fastest-growing region in the world is attributable to two factors. The first is that Asia's economic fundamentals remain in good

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shape. Levels of debt (both government and private) are low, inflation is healthy (unlike in the developed world, where deflation remains a real danger), and most Asian countries' banking sectors have little exposure to US sub-prime debt or to sovereign debt from the euro zone's peripheral economies. The second important factor that will support Asian growth over the next few years is the emergence of China as an independent engine of regional growth. Although the US is still the most important source of final demand for Asia as a whole, recent research from the European Central Bank suggests that China is now a greater source of final demand than the US for the Philippines, South Korea and Taiwan.
There are risks to Asia's outlook

Despite the generally positive outlook for Asia's economies, there are considerable downside risks. It is looking increasingly likely that some of the struggling peripheral economies in the euro zone will default on their debt. In that event, Europe's banking sector would suffer substantial losses on its holdings of those countries' bonds, possibly triggering another financial crisis in the region. Asia's direct financial exposure to weak peripheral euro zone countries is small but, like the US, Europe is an important export market. Aside from the direct impact on trade flows, renewed turmoil in Western financial markets is likely to lead to declines in asset prices in Asia. As was the case in 2008-09, the economies that would be hit hardest in the event of another global downturn are those that are most open and export-oriented, including Hong Kong, Singapore, Malaysia and Taiwan. The bigger, more domestically driven economies, such as India, China and Indonesia, would perform better. There is also a danger that monetary stimulus in the West fuels bubbles in some Asian markets. The fresh round of quantitative easing in the US has been criticised by some Asian policymakers on the grounds that it will escalate the bubble problems that they are facing, by encouraging further outflows of money from the US and into higher yielding assets in Asian economies. Calibrating policy so that these bubbles are deflated in an orderly fashion will be a key policy objective. A combination of exchange-rate appreciation, monetary tightening and macro-prudential policies, such as higher reserve requirements for banks, will be needed to prevent Asian economies from overheating. But currency appreciation is hurting the competitiveness of Asian exporters in economies that have floating currencies. In this sense, China's policy of suppressing the value of the renminbi is putting other Asian exporters at a disadvantage. Policy stimulus, surging capital inflows and a reluctance to allow currencies to strengthen have already fuelled some inflationary pressure in the region. Central banks are responding by raising interest rates—Malaysia, for example, has raised rates by 75 basis points since March and China has tightened quite aggressively—but some may now be falling behind the curve—Indonesia arguably falls into the latter camp. (Monetary tightening can also create problems by attracting more capital inflows.) Absorbing large capital inflows will remain a challenge for Asia's policymakers in the medium term, unless a major event, such as a crisis in the euro zone, triggers a rise in risk aversion. Asian currencies, despite the strong economic fundamentals of the region, are still considered risky.

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China's economy will continue to drive Asian growth

China’s real GDP growth is estimated to have accelerated to 10.2% in 2010, from 9.1% in 2009. This acceleration has been driven by rising activity across all parts of the economy, owing to loose credit conditions and a government-backed stimulus package that has boosted investment. Growth will fall back to 8.9% in 2011, as stimulus spending comes to an end and policy tightening leads to a slowdown in real estate investment. Weakening demand in key OECD markets will also serve to dampen export growth. Nevertheless, strong income growth will support consumption, and low real interest rates and credit conditions that will remain loose will also encourage big-ticket consumer purchases. In 2012-15 GDP growth will slow to an annual average rate of 8.1%. This largely reflects a slowing of investment as more cities in China reach the stage at which mass redevelopment becomes more politically complicated and economically costly. The contribution from net exports will also weaken, as the rising renminbi, anaemic growth in many developed economies and declining competitiveness cause export growth to slow relative to imports. Nevertheless, high levels of job creation and rising wages should ensure sustained rapid growth in consumption. The ongoing expansion of the provision of social services (particularly healthcare, education and pensions) will also support growth in fiscal spending, although a return to fiscal conservatism will act as a brake on public spending growth in the forecast period. There remains a risk that China could suffer from a sharp economic correction in 2011-15 that could cause economic growth to slow sharply. The Chinese authorities are taking steps to cool the economy. The People's Bank of China (PBOC, the central bank) ordered China's large banks to keep 18% of assets in reserves, up from a previous 17.5%, from November 29th 2010. Medium and small lenders also have to keep an additional one-half percentage point of assets in reserves. The move demonstrates how the monetary authorities at the PBOC are relying heavily on curbing bank credit in an effort to restrain inflation, which accelerated to 4.4% in October. The hike to renminbi reserve ratios (RRR) was the second in November and the fifth in 2010. Additional RRR hikes are likely in 2011, as are boosts to state-controlled interest rates and administrative measures to control credit and prices. Banks have already curtailed their lending sharply in 2010, according to official figures. Following government instructions, they provided voluminous new loans in early 2009 as part of a larger economic stimulus package, but new credit has remained far below the peak levels since February 2010. Property price rises are also moderating, as suggested by government data for 70 large cities, which showed year-on-year house price inflation down to 8.6% in October 2010 from 9.1% in September and 12.8% in April. However, the recent data are not sufficient to claim that the Chinese authorities have achieved a soft landing. The volatility of the property market militates against complacency with regard to the trend of real estate prices. The market is characterised by periodic sharp upward adjustments to prices. It is therefore too soon to tell whether the froth has been entirely taken out of the Chinese property market. Moreover, the quality of bank loans is being obscured by the off-balance sheet lending that many institutions are implementing through trust companies. The climbing consumer price inflation rate is also a serious concern.

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Food prices have driven much of the acceleration, but real wages are increasing sharply. The economy will need to adapt to higher real wages in the longer term, but in the short term the central bank may need to tighten monetary policy more aggressively to rein in price increases, possibly causing a more abrupt slowdown in GDP growth than we currently expect. The government’s ability to counteract economic crises is strong, as it proved in 2008-09, but its ability to do so without aggravating the economic imbalances that already threaten the economy is more open to question.
Asia and Australasia: China inflation and food prices
(% change, year on year)
CPI 25.0 20.0 15.0 10.0 5.0 0.0 -5.0 Jan Mar 2008 May Jul Sep Nov Jan 09 Mar May Jul Sep Nov Jan 10 Mar May Jul Sep Food prices

Source: Haver Analytics.

Fiscal and monetary stimulus helped Taiwan and South Korea to rebound from declines in output induced by the weakening of electronics demand in the developed world in late 2008. Policy is now being tightened. In South Korea, the Bank of Korea (the central bank) raised the policy rate, the base rate, by 25 basis points in July and November 2010, taking it from a record low of 2% to 2.5%, but we expect policy to remain broadly accommodative. Fiscal stimulus will be withdrawn during 2011. We estimate that South Korean GDP grew by 6.1% in 2010, but will decelerate to a more sustainable average of 3.9% a year in 2011-15. Taiwan’s GDP growth will slow from an estimated 10.1% in 2010 to an average of 4% a year in 2011-15.
Stimulus will be scaled back in ASEAN

The main economies in the Association of South-East Asian Nations (ASEAN), Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam, have all benefited from the strong recovery in global trade and the strength of demand from China. Most of these countries introduced massive stimulus programmes, the effects of which are beginning to fade. More recently, they have also been boosted by capital inflows, which have raised some concerns about overheating and rising inflation. In 2011 these economies will be focused on rolling back fiscal stimulus measures in an orderly fashion, and tightening monetary policy, although they will be wary of the effects that higher interest rates will have on their exchange rates, which have already appreciated strongly since early 2009. Thailand grew strongly in 2010 but its medium-term performance will be constrained by political instability, which will undermine investor and consumer confidence. Vietnam's economy is strong (6.8% growth is forecast in 2011), a trend that we expect to continue despite policy weaknesses and concerns about the banking sector following excessive credit growth in recent years.

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Global outlook

In India, real GDP growth on an expenditure basis is forecast to grow by an annual average of 8.7% in 2010/11-2015/16. India's strong growth fundamentals— high savings and investment rates, fast labour force growth and the rapidly expanding middle class—will ensure a steady performance, with little volatility in growth rates from year to year. Despite India's current strong growth performance, there are a number of clouds hanging over the local economy, including the stubbornly high inflation rate and the wide (albeit narrowing) budget deficit. It is for these reasons that we do not expect the government's GDP growth target (on an output basis) of 10% in 2011/12 to be achieved─our own forecast is that the economy will grow by 8.6%, a slight slowdown from the previous fiscal year. GDP growth will continue to be constrained by infrastructure bottlenecks, shortages of skilled labour and the difficulties of shifting resources from low-productivity agriculture to higher-productivity manufacturing. However, India clearly has huge scope for catch-up growth, not only with developed countries but also with other emerging markets.
Australia’s housing market looks overly frothy

In Australia, real GDP growth will decelerate to 2.6% in 2011 after reaching 3.2% in 2010. The slowdown in 2011 will be partly a reflection of softer growth in China as the effect of that country's extensive fiscal stimulus measures fades. Demand from China for Australia’s commodity exports was one of the cornerstones of Australia’s relatively strong performance during the global financial crisis. In the medium term, China’s development will continue to benefit the Australian economy, which we expect to grow by an average of 3.3% a year in 2012-15. The two main risks to our forecast are a more marked downturn in China's demand for Australia's raw materials than is the case in our central scenario and a crash in the local housing market. House prices have doubled in real terms since 1999, and growth in demand for housing is likely to be curbed by the fact that the government's grant for first-time home buyers, which was increased as part of the stimulus package, was cut sharply at the end of 2009.

Latin America: growth and inflation
(% change) Real GDP growth Mercosura Inflation Mercosura
Source: Economist Intelligence Unit.

2006 5.5 5.3 5.2 6.5

2007 5.6 6.8 5.3 6.3

2008 4.0 5.4 7.7 8.8

2009 -2.1 -0.4 5.8 7.5

2010 5.6 6.5 5.8 8.4

2011 3.8 4.1 6.4 9.0

2012 4.0 4.1 6.4 9.1

2013 4.3 4.5 6.0 8.3

2014 4.4 4.6 5.7 8.0

2015 4.4 4.5 5.6 7.8

a Full members: Argentina, Brazil, Paraguay, Uruguay and Venezuela.

Driven by a stronger than expected recovery in domestic demand, economic activity in Latin America surprised on the upside in 2010, and for the region as a whole we estimate a rebound in real GDP growth of 5.6%. Strong growth in export-oriented activity, a cyclical rebound of fixed investment and a boost to domestic demand from the rebuilding of inventories have been unsurprising. But private consumption has grown much more briskly than expected, reflecting a rapid recovery in employment and wages in parts of the region and a solid banking sector that has boosted credit to the private sector. In 2011 we expect regional GDP growth to slow to 3.8%, stemming partly, but not entirely,

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from trends in the global economy. In only a handful of exceptional cases will growth be stronger in 2011 than in 2010. In Chile, for example, we expect growth to accelerate in 2011, driven by statistical, carryover effects from the earthquake and the intensification of reconstruction investment, and in Venezuela we forecast a less steep contraction in 2011 than in 2010. Growth in Honduras, Jamaica and Trinidad and Tobago is also expected to strengthen in 2011, but this will reflect below-par performances in 2010 mainly related to adverse domestic conditions, which we expect to ease in 2011.
Mexico, the Caribbean and Central America worst hit by slowing US

For the most part, however, economic performance will weaken in 2011. The worst-affected countries will be those in the US-dependent north, in particular Mexico, Central America and the Caribbean, which are highly dependent on the US for their exports, foreign investment, workers' remittances and tourism. Although we have revised up our 2011 US growth forecast from 1.5% to 2.2%, the economy will remain fragile and dependent on policy support. Consequently, we continue to expect growth in subregions dependent on the US to decelerate. Currently we forecast that growth in Mexico will fall back from 5% to 3%, and in Central America GDP growth will weaken from 3.5% to 3.3%. In contrast, growth will be firmer in the commodity-exporting countries in South America (averaging around 4% in the Andean and Mercado Común del Sur—Mercosur, the Southern Cone customs union—subregions, compared with estimated growth of 5-6% in 2010), reflecting important external and domestic factors. Despite a projected deceleration in many Asian markets, demand in the region will remain much stronger than in the US; as such, Brazil, Chile and Peru (which have closer trading links with Asia) will benefit from stronger, exportand investment-led growth. The resumption of monetary easing in several major developed economies is prompting a resurgence of capital inflows into Latin America, as well as other emerging markets. Most countries have registered sharp increases in inward investment—both portfolio investment and longer-term foreign direct investment (FDI)—in recent months, which has contributed to appreciation pressures on local currencies. While this will help to support investment and consumption, this will prove a mixed blessing. The rise in inflows has prompted concerns on the part of policymakers in the region about resulting currency appreciation, export competitiveness and overheating. The Brazilian authorities have been particularly vocal about the impact of a surge in capital inflows on the domestic economy, alluding to the risk of "currency wars" if developed economies keep their currencies artificially low by resuming quantitative easing. In an attempt to dampen pressures on the Real, the Banco Central do Brasil (BCB, the Central Bank) has recently been buying large amounts of US dollars, and the government has increased a financial transactions tax on capital inflows into fixed-income markets from 2% to 6%. Although wide interest rate differentials, combined with strong growth prospects, have made Brazil particularly attractive to speculative investment inflows, other countries in the region, including Colombia and Costa Rica, are experiencing similar trends.

Rising capital inflows cause monetary policy dilemmas

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Interest rates are set to remain on hold, or even ease further

These developments raise uncertainties about the appropriate monetary policy stance. The difficulty facing several central banks is that inflation has already begun to rise, precluding further interest rate cuts in order to reduce spreads and stem capital inflows. In fact, a number of central banks had already begun to tighten monetary policy in mid-2010: Brazil, where first-quarter growth came in at 9% year on year, was the first to raise interest rates, lifting the benchmark Selic rate from 8.75% in April to 10.75% by July. Peru began raising interest rates in May, followed by Chile in June, on the expectation of rising inflationary pressure created by a robust rebound in demand. However, policy has been broadly kept on hold across the region since July, and we now expect much more moderate monetary tightening in 2011. In some of the weaker economies there may even be scope for further monetary easing. Inflationary pressures are among the strongest and the policy framework among the weakest in the region in Argentina and Venezuela. However, monetary tightening is not in prospect, given heavy government influence on respective central banks and a desire to sustain a consumption boom in advance of presidential elections in October 2011 (Argentina) and December 2012 (Venezuela). As a result, aggressive fiscal and monetary stimulus will maintain strong upward pressure on inflation. According to official data, in Venezuela inflation stood at 27.5% year on year in October 2010; in Argentina, inflation reached 11.1%, but the latter's data series is widely discredited, and all private and provincial surveys point to inflation of 25-30%. In both countries, wage negotiations in the public and the private sector are producing pay increases of upwards of 30%, raising the possibility of a wage-price spiral. In the medium term, we expect an acceleration of the region's real GDP growth in 2013-15 to an annual average of 4.3%, based on continued consolidation of macroeconomic stability and improving domestic demand. South American economies will be buoyed by persistent Asian demand for its soft and hard commodities exports, which is in itself also keeping the terms of trade favourable. Much of the rest of Latin America is set to grow more weakly, producing a two-speed regional growth pattern, but overall this still represents a positive performance relative to the region's long-term trend growth rate. However, these rates of GDP growth and correspondingly lower rates of growth in GDP per head will allow only limited catch-up with developed-country incomes per head, particularly when compared with emerging markets in Asia. There remain significant obstacles to the longer-term growth outlook. Reforms to costly and complex tax systems are needed in most of the region, and in many countries (particularly in Central America and Mexico) reforms are also needed to raise the level of tax revenue from little more than 10% of GDP. Even where tax collection has increased, it remains overly reliant on taxes from consumption (which is particularly regressive and inimical to a strengthening of domestic markets in a region with high poverty rates) and commodity exports (reliance on which leaves the public finances acutely exposed to external shocks). Shortcomings in the quality of public expenditure also persist. In most of the region capital and credit markets remain shallow, labour markets are inflexible, non-wage costs are high, skilled labour is in short supply and infrastructure

Deep distortions in Argentina and Venezuela hamper growth

Significant structural obstacles restrict medium-term growth rates

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upgrades are badly needed. In most countries, the political environment will not be conducive to the legislative reforms needed to address some of these issues. In Brazil, only piecemeal progress in a fragmented legislature is expected. In Mexico, the next presidential election is not until mid-2012, and in the interim the government will remain in a minority in Congress and unable to advance its reform agenda. Even thereafter, no single party is likely to win a working legislative majority, dimming prospects of structural (and muchneeded) reforms.
Middle East & Africa: growth and inflation
(% change) 2006 Middle East & North Africa Real GDP growth Inflation Sub-Saharan Africaa Real GDP growth Inflation
a Refers to Angola, Kenya, Nigeria and South Africa only.
Source: Economist Intelligence Unit.

2007 5.3 8.8 7.0 7.2

2008 5.9 13.6 4.9 11.8

2009 1.4 6.6 0.8 9.0

2010 4.1 6.3 4.2 7.8

2011 4.3 7.5 4.6 7.8

2012 4.4 7.1 5.5 7.3

2013 4.4 7.1 5.0 6.8

2014 4.6 7.3 4.8 6.4

2015 4.7 7.3 4.8 6.4

5.9 7.6 6.7 6.7

Expansionary fiscal policies in oilproducing countries will support growth

Economic growth in the Middle East and North Africa (MENA) picked up in 2010, boosted by the recovery in oil prices, a stronger global economy and loose domestic policy conditions. In 2011 somewhat higher oil output, despite OPEC's continued restraint, and persistently high government spending in oilproducing countries will lift growth again. We forecast growth at an annual average rate of 4.5% in 2012-15, as oil production rises more rapidly and some of the large infrastructure projects in the Gulf Co-operation Council (GCC) countries start to come on stream. Throughout the forecast period, regional growth will be buoyed by GDP growth in Qatar, which is rolling out a series of huge liquefied natural gas (LNG) plants, and in Iraq, which has considerable ground to make up after years of both war and sanctions. In the early part of the forecast period, countries in North Africa, particularly Tunisia and Morocco, will feel the impact of weak growth in the euro zone, which is the largest market for their exports and is also an important source of tourists and remittance inflows. Growth is unlikely to be sufficient to reduce currently high levels of unemployment among these countries' typically young populations. Other, relatively diversified economies with large domestic markets, such as Egypt and Israel, have weathered the downturn more comfortably, and are better placed to withstand a downturn in the EU.

The region faces a number of everpresent risks

Uncertainty about oil prices always clouds the regional outlook. However, our forecast of oil prices in a range of US$70-85/barrel is probably sufficient for oilproducing countries to maintain their fiscal expenditure. Security concerns are another perennial threat to regional growth. Specific security or political problems in countries such as Iran and Iraq could spill over into other countries, although this is not our main scenario. Saudi Arabia's economy is forecast to grow by an average of 4.1% a year in 2011-15, a slowdown from the annual average of 4.9% during the 2003-08 oil boom, but a recovery from 0.6% in 2009 and an estimated 3.4% in 2010, when
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Infrastructure and development projects will support Saudi growth

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Global outlook

growth was constrained by oil production cuts. A number of major projects are expected to come on stream in 2012-15, including refineries and petrochemical plants, which will drive robust growth rates. The services sector is also showing signs of strong growth. Oil output policy will remain a key determinant of economic growth, and relatively weak world demand for OPEC oil will constrain growth over the forecast period. Government spending will help to boost growth in the early part of the forecast period. In terms of demand components, private consumption is forecast to expand robustly, underpinned by strong population growth and by expansionary fiscal and monetary policies. As ever, oil price movements pose significant risks, as does the spectre of more corporate defaults.
Government spending in the UAE will underpin growth

Real GDP growth in the UAE is forecast to average 4.9% in 2011-15, slightly lower than the estimated rate of 5.2% in 2006-10. We expect non-oil exports and the services sector to grow strongly over the forecast period. The diversification programme will boost the output of the industrial sector, with some major projects expected to come on stream. However, the UAE will continue to rely heavily on the hydrocarbons sector. The impact on growth of high oil prices in the first half of the forecast period will be modest, owing to a small increase in oil production. Production will increase at a faster pace from 2012. High government spending, especially in Abu Dhabi, and improved consumer confidence will help to boost private consumption. Even if oil prices failed to reach forecast levels, the Abu Dhabi government would be able to draw on its vast overseas investments to sustain public spending. African commodity producers will continue to benefit from China's insatiable appetite for raw materials during the forecast period. This will be felt not only in terms of export revenue but also in terms of investment inflows. Regional economic growth is forecast to rebound strongly to an annual average rate of 4.4% in 2011-12. Demand will be boosted by a positive terms of trade shock as a result of higher commodity prices. By 2012-15 the regional economy is forecast to average growth of around 5.1% a year. Growth in South Africa, which is estimated at 2.8% in 2010, is expected to accelerate to 3.7% in 2011 owing to higher consumer spending, more business investment and stronger external demand. The outlook for 2012 is even brighter as the country rebuilds momentum following recession, helped by a more favourable global environment, and ongoing public and private investment. Prospects thereafter are a little gloomier, and we expect growth to average just 3.8% a year in 2012-15 because of persistent structural constraints, including skills shortages, high unemployment, crime, corruption and inefficient parastatals—while uncertainties in the build-up to the 2014 election will act as an additional constraint.

Africa will grow strongly in 2011, boosted by higher commodity prices

Political uncertainty could undermine Nigeria's economic outlook

In Nigeria, GDP growth is expected to average almost 7% a year in 2012-15. Growth is expected to be somewhat lower in 2011, owing to uncertainty related to the January elections and the global economy. Indeed, given the possibility of a period of severe political disruption, growth prospects could be damaged more significantly and much-needed legislation delayed. Structural problems, such as the dire infrastructure and widespread corruption, will continue to restrict economic prospects.

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Exchange rates
Concerns about the viability of the euro zone may weaken the euro

Currency markets, like other asset markets, are displaying an extraordinary degree of correlation at present. In broad terms, there are two trades: risk on and risk off. The "risk on" trade entails selling the dollar and buying risky assets, such as equities, corporate bonds, emerging-market assets, commodities, and commodity currencies such as the Australian dollar and Canadian dollar. The "risk off" trade entails a reversal of all the above trades in favour of the safe haven of the US dollar and US Treasuries. From July 2010 the risk on trade was in vogue. Selling the dollar was seen as a one-way bet in anticipation of the expansion of the US Fed's programme of quantitative easing (QE) in reponse to persistently high unemployment and fears about deflation. But since the Fed's announcement on November 3rd last year, which broadly validated market expectations about the scale and phasing of the expansion of QE, the dollar has recouped part of its recent losses against a range of currencies. Positioning against the dollar had become extreme, which created the conditions for a rebound. The dollar's rebound has coincided with a rise in US Treasury yields, which provide support to the dollar (although government yields have also been rising in most bond markets globally). The recent stablisation may prove only a temporary respite. The US dollar will continue to face headwinds from the Fed's ultra-loose monetary policy and from the US's large current-account deficit and external financing requirement. But the Economist Intelligence Unit believes that the rebound may mark the start of a sustained rally against the euro, whose very existence is in question as a result of the debt problems in the euro zone periphery. If the ECB launches its own version of QE as a way of supporting the debt markets of distressed euro zone members, the euro could fall fast and hard. The dollar may gain some cyclical support in 2011 if—as we expect—the US grows faster than the euro zone. That said, we do not expect either the Fed or the ECB to start raising interest rates until the latter part of 2012. It is also the case that in the current climate, positive surprises on the US economy can lead to pressure on the dollar, as they encourage global risk appetite and outflows from the dollar into other markets.

The yen will become vulnerable as Japan's savings rate falls

The yen has played its traditional role as a safe haven during periods of risk aversion. Since the onset of the financial crisis, the Japanese currency has made large gains against both the dollar and the euro. The yen has strengthened despite the poor structural state of the Japanese economy. Japan has attracted foreign portfolio equity inflows in 2010 but the yen's strength is primarily a reflection of its safe-haven status, underpinned by Japan's current-account surplus. Now that policy rates are close to zero in the US and the euro area, the yen has lost its attraction as a funding currency for carry trades. In the current climate of risk aversion and deleveraging, the yen is likely to remain strong. We do not believe that the recent intervention in the foreign-exchange market by the BOJ or its relatively small QE programme will materially change the short-run dynamics. But in the medium and long term, the yen is likely to weaken as demographic changes lower Japan's savings rate, which will erode Japan's current-account position, and could leave it dependent on external savings. Funding Japan's massive public debt will be a particular concern. Conditions in
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Global outlook

Japan's foreign-exchange and bond markets could suddenly become disorderly, although this appears more of a medium-term than a short-term risk. Emerging-market currencies are moving in a highly correlated fashion, fluctuating in accordance with global liquidity and risk appetite. Most strengthened (against the dollar and euro) in the period from June to November 2010 but have subsequently given up part of their gains. Further downward pressure on emerging-market currencies seems likely in the rest of 2010 as trading books are closed and profits locked in. But renewed appreciation for most emergingmarket currencies appears in prospect in 2011. Emerging markets will again grow more strongly than their counterparts in the West, attracting capital inflows. Global liquidity will remain plentiful. In addition, many emerging-market central banks will have to tighten monetary policy to contain inflationary pressures, increasing interest differentials with respect to the developed world. These pressures are partly a consequence of a surge in the price of raw materials and food, but they also reflect broader inflationary forces, as capacity constraints have emerged in the rebound from recession. Some emerging markets with managed floats may allow their currencies to appreciate as a means of curbing inflationary pressure, although they will be reluctant to lose competitiveness in a global economy characterised by a shortage of demand.
China shifts to a more flexible exchange-rate policy

On June 19th 2010 China announced that the renminbi's fixed peg to the US dollar—in place since mid-2008—would be replaced by a more flexible currency regime. The move is intended to deflect foreign criticism of China's exchangerate policy, but its broader economic impact will depend on the pace of appreciation. Since the renminbi was depegged, its appreciation against the US dollar has been modest, although it has accelerated since the start of September. We forecast that the renminbi will strengthen only gradually. This may not be enough to mollify China's critics, notably some members of the US Congress, particularly if US unemployment remains high. But the move to a more flexible regime—similar to the one prevailing from mid-2005 until the onset of the global financial crisis—is a step in the right direction that will help to boost domestic consumption and to balance the global economy. Fears that China could cause a collapse of the greenback by shifting large parts of its reserves out of the US currency have been calmed by assertions by Chinese poliymakers that they continue to see US Treasuries as a vital component of their reserves. Such fears are anyway ill-founded, given that the two countries are bound together by a mutual interdependence and that China's exchange-rate policy implies the accumulation of US assets.

The quest for export growth creates the prospect of competitive devaluations

Given weak demand in the developed world, many countries are hoping to export their way to growth. For example, the US administration has a stated goal of doubling exports within five years. QE programmes, such as that in the US and UK and now Japan, can be seen as means of weakening currencies and gaining competitiveness. Intervention in the foreign-exchange market is another way of achieving this result. Last September the BOJ intervened in the foreignexchange market for the first time since 2004, selling yen in an attempt to stem its rise. Its Swiss counterpart has intervened repeatedly in the foreign-exchange

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market in 2009-10, selling Swiss francs. Both the yen and the Swiss franc have been strong since the onset of the financial crisis given their safe-haven appeal. Emerging-market central banks have also been active. In Brazil, the Banco Central do Brasil (BCB, the central bank) has been buying large amounts of dollars and in late October the government increased a financial transactions tax on capital inflows into fixed-income markets from 4% to 6%, just two weeks after it raised it from 2%. China's policy of dollar purchases to hold down the value of the renminbi is coming under attack in the US but also in Europe.
The G20 meeting is unlikely to agree on co-ordinated action on exchange rates

In the past, governments have sometimes responded to the threat posed by disorderly foreign-exchange markets by agreeing co-ordinated action. The prospect of co-ordinated action seems remote in today's climate. A recent US proposal for ceilings to be set, at 4% of GDP, for current-account surpluses and deficits (these would be waived for some countries, such as large oil producers) appears to have been consigned to oblivion. The proposal met with an unenthusiastic response from China, Japan and Germany, three large surplus countries. Heads of state at the G20 meeting in South Korea in mid-November 2010 failed to agree on co-ordinated action in this area. Absent an accord, tensions over exchange rates are likely to remain a feature of the global economy in the medium term as countries struggle to create jobs and generate growth.

World trade
World trade
(% change; goods) World trade Developed countries Developing countries
Source: Economist Intelligence Unit.

2006 9.1 7.2 12.3

2007 7.7 5.1 11.9

2008 3.8 0.8 8.2

2009 -11.1 -12.4 -9.2

2010 12.4 11.2 13.9

2011 5.9 4.4 7.9

2012 6.3 4.0 9.2

2013 6.7 4.7 9.1

2014 6.7 4.7 9.2

2015 6.3 4.4 8.7

World trade recovery remains on track in the third quarter of 2010

World trade continues its recovery. In the third quarter of 2010 trade volumes are estimated to have grown by 13.7% compared with the year-earlier period. This is a slowdown after the 16.5% growth achieved in the second quarter, but it is to be expected given more demanding year-on-year comparisons. On current trends, world trade will recoup the losses suffered in 2009. During the downturn, the impact of the fall in world GDP on world trade growth was amplified by the fact that exports can show up several times in trade statistics, as intermediate products may be processed in several countries before reaching the location of final demand. In addition, highly cyclical consumer durables and investment goods are more commonly traded than other goods and services. The same effects have been working in reverse during the recovery. The Economist Intelligence Unit now estimates that global trade grew by 12.4% in 2010. In 2011 the rate of growth will halve. The most active restocking phase will be over and global output growth will slow. World trade is subsequently expected to grow by an annual average rate of 6.5% in 2012-15, driven by sustained growth in developing countries, as their integration into the global economy deepens. As consumers and companies in the developed world keep

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a close eye on costs, lower-cost producers from emerging markets will continue to gain market share. Trade between emerging markets will show the most dynamism. Because of subdued demand in the West, world trade growth will remain well below the peak years of globalisation in 2003-07.
World trade talks will not affect trade during the forecast period

The Doha round of world trade negotiations under the auspices of the World Trade Organisation (WTO) since 2001 remains in limbo. At the G20 summit in Pittsburgh in the US in September 2009, world leaders reaffirmed the goal of finalising an agreement by the end of 2010. This goal has not been achieved. While policymakers remain at loggerheads over exchange-rate policy and misalignments, substantive progress on multilateral trade talks is not in prospect. Among the issues preventing agreement are differences of opinion over the extent to which developing countries, such as India, can protect themselves temporarily against a surge in imports of agricultural goods. Developed economies, particularly the US, are pushing for a more aggressive reduction of trade barriers for manufacturing goods by developing countries, such as Brazil and India. Even if an agreement is reached, ratification would be problematic, and it would take time to implement. World trade negotiations are therefore unlikely to have more than a marginal impact on trade flows over the forecast period. Trade liberalisation on the bilateral and regional level has made more progress, particularly in Asia. The Association of South-East Asian Nations (ASEAN) has concluded three free-trade agreements (FTAs) with Australia, New Zealand and India. India concluded an FTA with South Korea in July 2009, and South Korea signed an agreement with the EU in October. A host of further FTAs and other arrangements to deepen economic ties (including through foreign direct investment and trade in services) are in the pipeline. The EU has launched formal negotiations with Canada and ASEAN, and there are extensive discussions on various issues to deepen trade relations between the US and the EU.

Rise in protectionism has been limited but remains a concern

According to estimates by the WTO, new import-restricting measures introduced by the G20 governments between September 2009 and February 2010 amounted to 0.4% of global trade. New measures introduced during the (longer) period of October 2008 to October 2009 affected 0.8% of global trade. Given that the measures are often not prohibitive (not completely eliminating trade in the affected goods) and that at the same time some trade restrictions have been eased, this is a surprisingly small rise in protectionism during the worst recession since the second world war. We assume that there will not be a subsequent increase in protectionism, and that the increase in trade restrictions may partly be reversed. But there is a risk that a growing number of countries will implement measures making use of loopholes in WTO agreements or breaching WTO rules in subtle ways. This means that lengthy proceedings in WTO committees will be needed to scale back such measures. More aggressive use of WTO rules to contain dumping could also amount to effective protectionism. The widespread perception that China manipulates its exchange rate to gain global market share means that Chinese exports will be a source of anger among policymakers in some parts of the world. Whether China's decision in June 2010 to introduce more flexibility into its exchange-rate policy can appease its foreign critics will depend on the rate at which the renminbi is allowed to

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appreciate against the US dollar. Thus far the renminbi's appreciation against the dollar has been minimal. In turn, the Chinese authorities have criticised the US Fed for expanding its QE programme as a means of weakening the dollar. The distance between the two sides appears difficult to bridge.

Commodity prices
Commodity price forecasts
2006 Oil prices Brent (US$/b) Non-oil commoditiesa Total Food, feedstuffs & beverages Beverages Grains Oilseeds Sugar Industrial raw materials Metals Fibres Rubber
a % change in US dollar prices.
Source: Economist Intelligence Unit.

2007 72.71 20.8 30.9 14.5 35.4 46.4 -32.0 11.2 10.6 18.1 7.0

2008 97.66 12.4 28.3 18.8 29.1 32.6 30.1 -5.1 -9.1 2.3 16.4

2009 61.86 -22.5 -20.4 1.0 -28.9 -22.1 29.6 -25.6 -28.4 -11.5 -25.6

2010 80.00 23.2 11.0 17.4 6.7 11.5 22.0 42.6 38.5 37.1 75.3

2011 82.00 9.5 13.1 -3.0 21.6 16.3 -9.9 5.0 8.0 0.7 -4.1

2012 81.25 -4.4 -5.6 -10.4 -5.7 -1.5 -12.8 -2.8 -0.6 -7.1 -9.1

2013 78.25 -4.0 -4.7 -8.1 -0.7 -8.8 -1.5 -3.1 -1.6 -5.6 -8.4

2014 75.50 1.5 0.3 -1.9 0.6 1.7 -6.3 3.0 4.0 -2.1 3.3

2015 71.00 0.1 1.1 0.1 0.6 2.3 3.3 -1.1 -1.6 -2.1 3.2

65.39 31.2 16.1 8.6 25.7 3.0 49.5 49.6 62.4 6.4 38.7

Oil: Dated Brent Blend oil prices averaged US$76.4/barrel in the third quarter of 2010. However, prices started to rise steadily in September and stood at just over US$90/b in early December. On a fundamental level, the recovery in prices reflected persistent strength in consumption growth. In particular, OECD consumption, led by the US, was growing healthily in the third quarter. Prices were also being supported by renewed investor appetite for risk and the weakness of the US dollar. Further monetary easing in the US and the extension of tax cuts in December gave oil prices a boost. In December the futures curve was flirting with backwardation, which encourages financial investment in the commodity as it reduces the cost of rolling over futures exposure. The Economist Intelligence Unit expects renewed weakness in the euro to lead to a stronger US dollar in 2011. However, the market will remain supported by, albeit slowing, consumption growth and investor interest.
Conservation and the adoption of renewables will constrain OECD demand

Following two consecutive years of contraction, global oil consumption recovered strongly in 2010, growing by an estimated 2.4%. We expect global consumption to average annual growth of 1.8% in 2011-15. US consumption growth was particularly strong in the third quarter, and although there were signs of slower growth in the fourth quarter, we estimate that consumption grew by a buoyant 1.8% in 2010. US petrol (gasoline) consumption picked up over the summer months in 2010 but remains relatively subdued, reflecting high unemployment and the depressed nature of household demand. We have revised up our forecast of consumption in 2011 in tandem with our more positive view on GDP growth in that year. We now expect consumption to grow by about 0.5% (-0.2% previously) in 2011, before renewed contractions in

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oil consumption in 2012-15 as measures to encourage fuel efficiency and reduce dependence on fossil fuels start to have an impact. EU consumption is estimated to have contracted by 1.3% in 2010, with contractions averaging 0.2% a year in 2011-15. Economic growth in the region will be subdued, but the expected falls in consumption are also a result of conservation and efficiency gains. OECD consumption growth is estimated to have averaged 0.6% in 2010. Following our upward revision to US consumption, OECD consumption is now expected to be broadly flat in 2011-12, before contracting thereafter by an annual average of 0.2% in 2013-15. The increasing use of ethanol and biofuels in the transport sector and higher standards of fuel efficiency will dampen growth. Growth in consumption will be concentrated in non-OECD countries—particularly China, the Middle East and India—as their economies grow strongly, incomes rise and governments continue to subsidise retail fuel prices.
OPEC production will be constrained in 2011

OPEC has maintained a production ceiling of 24.85m barrels/day (b/d) since January 2009 in response to weaker global oil consumption growth. Initially, when oil prices were very low, compliance was good, standing at 75-80% at end-March 2009. However, compliance subsequently slipped and stood at just 55% in October 2010, according to the International Energy Agency (IEA). OPEC met again in October, but, as expected, there was no change in the cartel's output ceiling and there appeared to be little discussion of the relatively poor compliance. Since the meeting, with oil prices moving above US$80/b, the Saudi oil minister, Ali Naimi, commented that OPEC's preferred price range was US$70-90/b, up from what had appeared to be the preferred range of US$7080/b. Given the weak demand outlook (and higher prices), OPEC is expected to maintain its production ceiling in 2011, but compliance could slip further as, particularly the more cash-strapped, member states seek to boost export and fiscal revenue. Moreover, many member countries have new fields in development, which are due to come into production this year and in 2012, and they will be reluctant to mothball capacity before it is operational. Growth in non-OPEC production is estimated to have slowed in 2010 to 2.2% as gains in output in Canada, Brazil, the US and China were partially offset by declining production from the North Sea and Mexico. In 2011 the Jubilee field offshore Ghana is expected to become operational and additional supply will come from the Gulf of Mexico, Canada's tar sands, China and the Caspian producers. Output from Mexico and the North Sea is expected to fall over the forecast period, owing to maturing fields and the lack of new investment (particularly in Mexico). Large increments to non-OPEC supply, primarily from China, Brazil and Kazakhstan, are not expected until 2013 at the earliest. Canada's conventional oil output has stabilised but plans to increase nonconventional supply have been subject to repeated delays. In more conducive market conditions, OPEC could produce at a much higher level. Saudi Arabia has a number of large projects coming on stream, and Nigeria, Angola, Algeria, Qatar and Libya also have the potential to increase output. However, the call on OPEC will be limited. Saudi Arabia is expected to be particularly cautious about ramping up production, unless there is markedly stronger demand in 2011 than currently anticipated. In the latter half of the

Growth in non-OPEC output is expected to slow

OPEC is sitting on considerable spare capacity

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forecast period, we expect growth in OPEC supply to average just over 3% a year on the back of higher output from Nigeria, Angola and the Gulf producers. Geopolitical risk does, however, weigh heavily on our supply forecasts— tensions between the West and Iran over its nuclear programme remain high, and an intensification of security problems in Iraq or Nigeria is possible.
Ample capacity will act as a constraint on prices in 2011-15

A rebound in consumption growth, coupled with persistent OPEC supply constraint, will support oil prices in 2011. Furthermore, we expect speculators to continue to invest in the market, given the ultra-low interest rate environment, robust growth in developing economies and the uncertain outlook for other asset markets. However, relatively high global stocks and ongoing economic uncertainty will prevent significant price increases. We expect the impact of economic stimulus packages to fade in 2011 and for renewed strength in the US dollar to lead to falling prices during the year. Optimism about the growing pattern of consumption in the emerging world will support prices in 2012. At the same time, however, increasing use of biofuels will also start to have an impact on the transport sector in the developed world (where the impact is greatest because of higher levels of car ownership), and fuel efficiency will see improvements. China will also be under pressure to reduce the energy intensity of its growth, both from international sources and domestically, as it seeks to curtail an increasing reliance on imported oil. Heightened efforts at conservation and improved efficiency are expected, but they will only serve to prevent more dramatic increases in China's consumption, as incomes and levels of car ownership rise. These trends, together with the prospect of large increments in supply (particularly by Kazakhstan and Brazil) from 2014, suggest that prices will start to ease in 2013-15.

The medium-term outlook for base metal prices is positive

Hard commodities: Prices were boosted in 2010 by strong Chinese buying and some restocking in the OECD, where inventories were typically at historical lows. Stimulatory fiscal and monetary policies across both the developed and developing worlds boosted consumption generally and investor interest was strong. Prices rose particularly strongly in the fourth quarter of the year, owing to US dollar weakness and the announcement of further monetary and fiscal easing in the US. We expect China to remain the primary source of demand growth into 2011, but we also expect Chinese consumption growth to ease as a result of government efforts to cool the property market, in particular, as well as efforts to curb emissions. Furthermore, the restocking cycle for many commodities is now complete in the OECD. Unless an individual commodity has an especially tight market balance or negative supply developments, such as copper or tin, this suggests that prices will struggle to improve much from current levels. In the medium to longer term, we expect prices for base metals to be supported by robust growth in the developing world and ongoing urbanisation, and the fact that the supply profiles for many metals tend to be volatile. Mining output can easily be hampered by inclement weather, energy shortages, transport bottlenecks, union activity or a difficult regulatory environment. However, prices generally are still expected to slip from the elevated levels seen in late 2010.

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Gold prices will remain high until 2012

Gold prices have been rising for most of 2010 and stood at over US$1,400/troy oz in early December, up from an average of US$1,109/troy oz in the first quarter. Although jewellery consumption recovered in 2010 to grow by an estimated 7%, it was primarily investor demand, coupled with a tight physical market, that fuelled the price rise. Investor demand—both physical and speculative—is expected to continue to support gold prices in 2011. The supply/demand fundamentals are also set to improve, with the market moving into a sizeable deficit in 2010-12. However, these trends will be offset by the forecast tightening of monetary policy in 2012, which will restrain economic growth and investment in gold, as well as the expected strengthening of the US dollar, which has historically moved inversely to the price of gold. As a result of these conflicting trends, we estimate that the gold price rose to an average of US$1,222/troy oz in 2010, with a further rise to US$1,329/troy oz forecast for 2011. The price will start to weaken in 2012, with a more marked decline in 2013 owing primarily to higher global interest rates and a loss of investor inflows. Soft commodities: In 2010 agricultural commodity prices benefited from the general return of investor risk appetite and from weather-related disruptions to supply in many key producers. Reports of a sharp decline in wheat harvests in parts of the former Soviet Union—Russia, Ukraine and Kazakhstan—and Canada led to a spike in wheat prices in the second half of the year. The global wheat harvest is now estimated to have fallen by 5% in 2010, but this still represents the third-largest crop on record and is sufficient to maintain higher than average world stocks. In the wake of considerable crop damage in 2010 (floods in Pakistan, China and India, and drought and wildfires in Russia), subsequent trade restrictions and continued investor interest, agricultural commodity prices are expected to remain strong in 2011. Our food, feedstuffs and beverages (FFB) index is now expected to have risen by 11% in 2010 and is forecast to rise by a further 13.1% in 2011. Assuming normal weather conditions, market surpluses are expected to return in 2012 and prices will ease somewhat. Agricultural prices, more generally, will be supported in 2013-15 by the structural shift upwards in demand, given the increase in emerging-market consumption (particularly for livestock feed), population growth and the impact of biofuels production. There is also ongoing structural change on the supply side, reflecting increasing urbanisation (and less arable land), declining global water levels and the unpredictable consequences of climate change on weather patterns.

Agricultural commodity prices are expected to rise in 2011

Individual commodity price forecasts
Aluminium (US$/tonne) Barley (US$/tonne) Coal (US$/tonne, Australia) Cocoa (US cents/lb) Coffee (Arabica) (US cents/lb) Coffee (Robusta) (US cents/lb) Copper (US cents/lb) Cotton (US cents/lb) Gold (US$/troy oz) Iron ore (US cents/dry metric tonne unit) Lead (US cents/lb) 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2,594.0 2,661.2 2,620.9 1,706.8 2,164.7 2,232.5 2,130.0 2,000.0 2,155.0 2,200.0 151.2 263.4 256.3 159.3 188.0 178.8 185.0 190.0 205.0 210.0 49.1 65.7 127.1 71.8 97.1 99.3 91.5 98.8 92.0 90.0 72.1 88.6 117.1 131.0 144.0 136.3 131.5 135.0 130.0 128.0 114.4 123.5 139.8 143.9 194.4 202.7 180.3 150.0 140.0 135.0 67.6 86.6 105.2 74.6 74.9 73.7 65.6 60.0 65.0 70.0 305.6 322.3 316.2 233.6 342.5 371.3 376.3 380.0 390.0 370.0 58.6 64.8 72.1 62.7 99.3 98.8 87.8 80.0 78.0 75.0 604.3 696.7 871.8 973.0 1,222.3 1,328.8 1,232.5 1,093.8 962.5 875.0 75.3 82.9 140.6 114.2 151.9 121.3 110.0 125.0 120.0 130.0 58.4 117.2 95.0 78.0 96.5 102.5 117.5 120.0 130.0 135.0

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Individual commodity price forecasts
Maize (US$/tonne) Natural gas (US$/mmbtu, Europe) Natural gas (US$/mmbtu, US) Nickel (US$/lb) Oil: Brent (US$/b) Oil: Dubai (US$/b) Oil: IEA (US$/b) Oil: WTI (US$/b) Palladium (US$/troy oz, London) Palm oil (US$/tonne) Platinum (US$/troy oz) Rapeseed oil (US$/tonne) Rice (US$/tonne) Rubber (US$/tonne) Silver (US cents/troy oz) Sorghum (US$/tonne) Soybean oil (US$/tonne) Soybeans (US$/tonne) Soymeal (US$/tonne) Steel (US$/tonne) Sugar (US cents/lb) Sunflowerseed oil (US$/tonne) Tea (US$/kg) Tin (US$/lb) Wheat (US$/tonne) Wool (Aus cents/kg) Zinc (US cents/lb)
Source: Economist Intelligence Unit.

2006 123.1 8.47 6.72 11.0 65.4 61.4 64.9 66.1 318.8 478.3 1,135.0 793.8 311.0 2,312.8 1,156.9 139.3 598.8 265.5 220.3 556.0 14.8 658.0 1.9 4.0 200.3 752.8 147.6

2007 170.1 8.56 6.98 17.0 72.7 68.4 72.1 72.3 350.3 780.3 1,299.0 969.1 335.4 2,474.4 1,340.8 185.3 881.4 378.2 320.5 554.8 10.1 1,021.9 2.1 6.6 268.7 955.3 147.2

2008 2009 2010 2011 2012 227.8 172.0 195.5 260.0 267.5 13.41 8.71 8.15 8.24 8.41 8.86 3.95 4.46 4.39 4.63 9.6 6.6 9.9 11.0 9.9 97.7 61.9 80.0 82.0 81.3 93.8 61.8 78.8 81.2 80.4 96.9 61.4 79.4 81.3 80.6 99.6 61.7 79.4 82.8 82.1 353.2 257.4 532.4 800.0 675.0 948.6 682.8 887.0 1,091.7 1,045.6 1,563.2 1,204.8 1,614.8 1,787.5 1,700.0 1,329.2 858.8 999.2 1,258.9 1,249.9 676.0 566.3 505.3 493.8 482.5 2,880.8 2,142.5 3,755.5 3,601.3 3,275.0 1,500.0 1,469.4 1,884.0 2,059.6 1,910.4 207.8 167.8 186.3 181.3 186.3 1,258.3 848.8 939.0 999.0 971.6 474.9 409.8 412.0 455.0 442.5 451.6 420.0 457.7 505.4 491.5 889.1 489.2 648.3 555.8 515.0 13.1 16.9 20.7 18.6 16.3 1,498.9 854.8 1,068.2 1,494.0 1,650.8 2.3 2.7 2.9 2.4 2.0 8.4 6.2 9.2 11.3 9.8 340.9 234.8 241.8 277.5 245.0 891.5 804.3 910.0 933.8 925.0 85.3 75.1 99.5 109.6 126.8

2013 270.0 8.46 4.74 9.5 78.3 77.5 77.6 79.0 550.0 900.0 1,550.0 1,150.0 480.0 3,000.0 1,695.3 190.0 950.0 420.0 450.0 588.8 16.0 1,400.0 2.0 9.0 240.0 915.0 130.0

2014 260.0 8.48 5.00 10.0 75.5 74.7 74.9 76.3 500.0 915.0 1,500.0 1,200.0 500.0 3,100.0 1,491.9 200.0 965.0 425.0 470.0 600.0 15.0 1,350.0 2.1 8.9 250.0 900.0 132.0

2015 250.0 8.19 5.08 10.3 71.0 70.3 70.4 71.7 525.0 950.0 1,600.0 1,225.0 525.0 3,200.0 1,356.3 225.0 970.0 430.0 500.0 625.0 15.5 1,300.0 2.2 8.5 260.0 900.0 135.0

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Global assumptions
(Forecast closing date: December 10th 2010)
2006 Real GDP growth (%) World (market exchange rates) US Japan Euro area China World (PPP exchange rates)a OECD Non-OECD World trade growth (%) Goods Consumer price inflation (%; av) World US Japan Euro area China OECDb Export price inflation (%) Manufactures (US$) Commodity prices Oil (US$/barrel; Brent) % change World non-oil commodity prices (US$, % change) Food, feedstuffs & beverages Industrial raw materials Main policy interest rates (%; end-period) Federal Reserve Bank of Japan European Central Bank Bank of England Exchange rates (av) US$ effective (2005=100) ¥:US$ US$:€ Rmb:US$ US$:£ C$:US$ ¥:€ £:€ Exchange rates (end-period) ¥:US$ Rmb:US$ US$:€ 4.1 2.7 2.0 3.1 12.7 5.1 3.1 8.5 9.1 3.3 3.2 0.2 2.0 1.8 2.2 3.7 65.39 20.1 31.2 16.1 49.6 5.25 0.25 3.50 5.00 99.7 116 1.26 7.97 1.84 1.14 146 0.68 119 7.79 1.32 2007 3.9 1.9 2.3 2.8 14.2 5.2 2.7 9.2 7.7 3.4 2.9 0.1 2.1 4.8 2.1 8.7 72.71 11.2 20.8 30.9 11.2 4.25 0.50 4.00 5.50 95.8 118 1.37 7.61 2.00 1.08 161 0.68 112 7.29 1.46 2008 1.5 0.0 -1.2 0.4 9.6 2.7 0.3 6.2 3.8 4.9 3.8 1.4 3.1 6.0 3.2 8.5 97.66 34.3 12.4 28.3 -5.1 0.10 0.10 2.50 2.00 92.5 103 1.47 6.95 1.85 1.07 152 0.79 91 6.83 1.39 2009 -2.2 -2.6 -5.3 -4.1 9.1 -0.8 -3.4 3.0 -11.1 1.5 -0.3 -1.4 0.2 -0.7 0.0 -3.3 61.86 -36.7 -22.5 -20.4 -25.6 0.10 0.10 1.00 0.50 97.0 94 1.39 6.83 1.56 1.14 131 0.89 93 6.80 1.43 2010 3.6 2.7 3.5 1.6 10.2 4.7 2.7 7.2 12.4 2.9 1.5 -0.9 1.3 3.2 1.3 3.2 80.00 29.3 23.2 11.0 42.6 0.10 0.10 1.00 0.50 94.0 88 1.32 6.76 1.55 1.03 116 0.86 82 6.76 1.34 2011 2.7 2.2 1.2 0.9 8.9 3.8 1.8 6.3 5.9 2.7 1.0 0.1 1.2 3.8 1.1 0.7 82.00 2.5 9.5 13.1 5.0 0.10 0.10 1.00 0.50 94.1 82 1.25 6.49 1.54 1.03 103 0.81 83 6.49 1.20 2012 2.9 2.1 1.3 1.3 8.6 4.0 2.0 6.5 6.3 3.0 1.9 1.0 1.5 3.7 1.7 0.2 81.25 -0.9 -4.4 -5.6 -2.8 0.75 0.75 1.75 1.75 95.5 82 1.20 6.37 1.51 1.02 99 0.80 81 6.37 1.19 2013 3.0 2.3 1.1 1.6 8.2 4.1 2.2 6.4 6.7 3.2 2.5 1.0 1.6 4.1 2.0 1.8 78.25 -3.7 -4.0 -4.7 -3.1 2.75 1.50 3.00 3.00 94.9 81 1.18 6.16 1.54 1.00 96 0.77 81 6.16 1.17 2014 3.0 2.2 1.2 1.9 8.0 4.2 2.2 6.4 6.7 3.3 2.8 0.9 1.7 4.0 2.1 1.2 75.50 -3.5 1.5 0.3 3.0 4.75 1.75 3.00 3.00 95.3 82 1.16 5.95 1.56 0.98 95 0.74 83 5.95 1.17 2015 3.1 2.5 1.2 2.0 7.4 4.3 2.1 6.2 6.3 3.4 2.8 1.5 1.9 3.8 2.3 1.8 71.00 -6.0 0.1 1.1 -1.1 5.10 2.00 4.00 3.50 95.1 84 1.17 5.94 1.58 0.97 98 0.74 84 5.81 1.17

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