Since the second half of 2008, economies in OECD countries have been deteriorating dramatically. Financial crisis, collapse in housing prices and increase in unemployment put the long-term expansion to an end and as shown in GDP growth in recent quarters, several developed countries have entered recession. Consumer demand, contributed over 60% of a country's economic growth, should continue to deteriorate for some time despite massive fiscal stimulus.
Looking into 2009, output and GDP in developed countries are expected to contract while economies in emerging markets are slowing down rapidly. Expansionary monetary policies around the world will be unprecedented but the effectiveness will not be seen until the second half of next year. After the gradual 'healing process' in 2H09, recovery should be seen in 2010.
Inflation will come down further in 2009 and there is risk of deflation if weak GDP across the world repeats for several quarters. However, analysts' forecast did not factor this in yet.
Near-term outlook in US has deteriorated sharply and economy is expected to decline by 2% in 2009 with most of the contraction occurring in early 09. Plummeting housing prices and rising unemployment constrained spending and investments as consumers prefer to save more money. As the Fed slashed policy rates to 0-0.25% in December and the effective funds rate has already been trading well below target and close to zero, interest rate outlook is of less concern. The dominant theme will lie on the Fed's ZIRP and quantitative easing policy which are expected to take effect in mid-09 and recovery is expected to be more significantly in 2010. Morgan Stanley expects 'significant fiscal stimulus, likely early in 2009 when the Obama Administration takes office, will limit the recession downside and help promote a modest recovery in 2010'.
After showing GDP contraction in 2 consecutive quarters (2Q08 and 3Q08), the Eurozone has technically entered recession. Going into 2009, the 15-nation region's economic condition is expected to be the worse after World War 2. GDP growth should be around -1.5% while CPI should be lowered to just1% and this gives the ECB a lot of rooms to cut interest rates further. Moreover, the central bank is likely to expand budget deficits. Deutsche Bank foresees 'individual countries to be forced to do more and the flexibilities of the reformed Stability Pact will be used…the euro area deficit to rise to 4.7% of GDP in 2009 and higher still in 2010'.
Credit tightening and economic uncertainty reduces investment appetite and spending. Decline in demand and consumption will cause corporations to cut labor which in turn drags down consumption further. This vicious cycle will likely continue until 2H09. Morgan Stanley believes 'investment spending - both machinery and equipment as well as construction - to be hit much harder than consumer spending'.
As the growth from net export is expected to deteriorate, the largest economy in Asia will face the worst economic decline since 1998 and turnaround is not anticipated to be seen until 2H10. Credit Suisse expects capex to deteriorate further in 2009 as 'sentiment has weakened substantially amid a sharp fall in foreign demand for capital goods and the yen's appreciation'. Deflation is likely to be seen next year and is expected to get worse in the second half. Merrill Lynch believed the Bank of Japan should take some measures target higher inflation.
In fact, BoJ is facing a tough time in the coming year as there are not many monetary tools available. On Dec 19, the central slashed the overnight lending rates by 20 bps to 0.1% and announced to increase outright purchase of JGB and commercial papers. It's not surprising for the central bank to cut rates further in 1Q09 and it will bring us to ZIRP again. On fiscal side, since September, Japan's government has allocated around 8 trillion yen for emergency spending. However, as government debt has already been at very high level, there's limited room for fiscal expansion.
Economy is expected to contract 1.5% in 2009 and then recover by 1.3% in 2010.Although the UK's GDP forecast is similar to that of the Eurozone, massive depreciation in pound should help boost exports. In other words, domestic demands in the nation should be weaker than the 15-nation Eurozone. Inflation will fall sharply in 2009, especially for RPI which is expected to sink to negative zone due to lower property prices and mortgage rates.
In December, the Bank of England lowered interest rate to 2%. The consensus expects it to continue the easing policy and it's possible for the rate to reach 0.5%. According to Deutsche Bank, 'even if Bank Rate is not cut to zero, questions will be asked about the need for quantitative easing'. Morgan Stanley does not believe interest rate will fall to zero. Instead, the bank expects increases in interest rate in late 09.
The United States imports 30% of Canada's production. Contraction in US economy pushed Canada into recession since late 2008. Domestically, the nation's economy also has lost momentum as indicated by poor data such as housing starts, employment and retail sales. Looking to 2009, a deeper and longer recession, as well as lower inflation will be seen through 1H09. Credit Suisse said 'the effects of the global financial crisis have caused the private sector (i.e., households and businesses) to become extraordinarily cautious. This should lead to an increase in private savings and de-leveraging of the private sector's balance sheet'. Merrill Lynch forecasts real GDP will contract by 1.2% in 2009 following 0.6% growth in 2008 and recession won't likely end until Q4 2009.
In 4Q08 alone, the Bank of Canada aggressively took interest rate down by 150 bps to 1.5%. Obviously this is not the end and it's widely anticipated that BoC will reduce policy rates further by 100 bps by 2H09. Merrill Lynch expects BoC will cut another 50 bps on January 20 and 'the risk is that the BoC will need to go further in its bid to stimulate, potentially into non-conventional policy territory. This more aggressive easing, and the disinflationary fundamental developments that drive it, are expected to join with stronger a US bond market in pushing Canadian government yields down in 2009'.
According to our estimates, Australia is the only developed country with non-negative economic growth in 2009. However, whether Australia will join its counterparts into recession remains debatable. Goldman Sachs views early 2009 as 'the most challenging economic environment for the Australian economy since the depths of the 1991-92 recession'. UBS expects 'the most significant moderation in Australia's growth rate since the 1990's recession' but 'after a period of no growth in 1H09, a modest recovery will unfold in 2H09'.
Inflation will come down further in 2009 as prices of oil, base metals and other commodities have declined significantly. On monetary side, RBA should remain aggressive in cutting interest rates. Morgan Stanley forecasts the cash rate target to fall to 2.5% but believes it will 'cushion the downturn, but not prevent a hard landing'.
New Zealand's economic downturn is more of domestically-generated. Recent economic data suggested further cutback in capex and employment in 2009 which will weaken housing price further. Sharp fall in commodity prices made inflation out of steam and it gives the central bank rooms to reduce interest rates. Deutsche Bank expects 'a minimum further 100bps of easing this month, likely more, with an OCR of around 3.5% forecast to be seen by mid 2009'. Citigroup expects New Zealand will have GDP growth of 0.5% in 2008 and 2009 with risk to the downside. Citigroup also expects RBNZ to reduce interest rates to 3.5% by March 09.