As the coronavirus threatens to derail the revival in global economic growth, 2020 could potentially be the weakest since 2009, the height of the global financial crisis.
The coronavirus threatens to derail the revival in global economic growth which began in the latter part of 2019. Economic indicators up to January continued to show an improvement in activity with business surveys signalling rising orders and output. However, confidence in the sustainability of the upswing has been undermined by the virus, officially known as COVID-19, which has led to the quarantining and shutdown of large swathes of China’s economy. The virus has now spread to many other parts of the world, with Korea, Japan and Italy particularly affected.
The near term impact from COVID-19 is significant and largely as a result of the virus we are downgrading our forecast for global growth in 2020 to 2.3% from 2.6%. Such an outcome would make this year the weakest since 2009, the height of the global financial crisis.
Our baseline forecast assumes that the COVID-19 outbreak is brought under control and that activity in China can recover to its pre-crisis level by the end of the second quarter. Global activity should then recover relatively quickly as production levels return to normal. On this basis the recovery is delayed not derailed, as the factors which supported the recovery remain in place.
Central banks around the world have lowered interest rates in the past year to spur economic growth and the full benefit of this has still to fully flow through to activity. Similarly, the reduction in trade tension as a result of the phase one trade deal between the US and China should lift growth as uncertainty ebbs.
In the US, first quarter activity is being depressed by the decision by Boeing to halt production of its 737 MAX jet. With inventory of planes high due to safety concerns, delivery is dependent on regulatory clearance. Production of these new jets has been halted, but a gradual recovery in this area of industrial production should help lift growth in the second half of 2020 and into 2021. When combined with COVID-19 effects, first quarter growth is expected to be flat and overall GDP growth for 2020 is downgraded to 1.6% from 1.8%.
With China at the epicentre of the coronavirus crisis, it should be no surprise that we downgrade emerging market (EM) growth from 4.5% to 4.1%. China itself accounts for the largest part of our downgrade (down 0.5 percentage points to 5.5%), even assuming a relatively swift resolution to the outbreak. More than 10% of the first quarter's working days have been lost, and the return to work will be gradual given the need for quarantine measures and a dispersed workforce after the New Year holidays.
A weaker than previously expected Japanese economy along with Japan’s vulnerability to the impact of the coronavirus (through tourism, exports and its supply chains) leads us to downgrade the growth outlook for the first half of 2020. We now forecast a Japanese recession in the first quarter. Early indications from export data and the Purchasing Managers’ Index (PMI), which shows economic trends in the manufacturing and service sectors, are that activity continues fall.
The eurozone saw a disappointing end to 2019, with weak external demand and protests in France and Italy dragging on growth. Domestic demand is forecast to remain robust over the forecast horizon, but the coronavirus disruption is likely to have a significant, but short-term impact. For the major exporters, supply chains are likely to be disrupted, reducing both the supply of imported intermediary goods, and demand for finished final and capital goods, especially from Asia.
France and Italy will likely see reduced tourism activity. When combined with the coronavirus outbreak this could be enough to push Italy into a technical recession in the first quarter. GDP is forecast to fall from 1.2% in 2019 to 1% for 2020 (revised down from 1.2%), before recovering to 1.4% in 2021.
Meanwhile, the UK bucks the trend in the forecast update by receiving an upgrade to GDP growth for 2020 to 1.1% (previously 0.8%) before rising to 2.2% in 2021 (revised up from 2.1%). Companies have reduced their stock levels more aggressively than had been anticipated at the end of 2019, which removes a potential drag for this year. Growth will gradually gather momentum as business investment begins to recover, followed by consumer spending. The government also appears ready to loosen fiscal policy by around 0.5% of GDP in the forthcoming budget, although the impact will be limited at first.
Global inflation remains relatively benign in the forecast, ticking up to 2.6% this year before declining to 2.3% in 2021. Lower oil and commodity prices combined with the lagged effects of last year's slowdown are expected to keep prices in check. Wages are likely to rise as labour markets remain tight, but not accelerate markedly.
We see some inflationary pressure in EM where we expect the supply disruptions, combined with existing inflationary pressures (largely from food prices), to overwhelm the lower demand effects for prices, and drive inflation higher, particularly in China. Against this backdrop, policy makers have considerable space to keep policy loose or ease further.
Recent developments have increased our conviction that the US Federal Reserve (Fed) will ease further in April. We also forecast a reduction in China’s benchmark rate in 2020. With both growth and inflation revised down in the forecast, we have kept the European Central Bank’s cut in its deposit rate (-0.50% to -0.60%), but have pushed this to the second quarter.
In the UK, our growth and inflation forecast is consistent with a rate hike in 2021, although the Bank of England will be keen to proceed slowly. Japan’s central bank will likely keep rates unchanged.
The risk to our forecasts is that the coronavirus develops into a pandemic which hits activity harder resulting in a global recession.
The views and opinions contained herein are those of Keith Wade and may not necessarily represent views expressed or reflected in other communications, strategies or funds.
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