UK: Deloitte Monday Briefing (On Tuesday): Three Things That Keep The IMF Awake At Night

Last Updated: 7 May 2014
Article by Ian Stewart

* I received a text from my mother a week ago saying that that week's Monday Briefing – which talked of the sweet spot of the economic cycle and a Goldilocks recovery – was sounding overly euphoric.

* It is a fair point (and not just because of the source). In economics, euphoria tends to precede a fall.

* Talking to clients and colleagues last week I was reminded that not everyone feels as upbeat as the respondents to the latest CBI Industrial Trends Survey which puts UK business optimism at the highest level since 1973.

* There certainly is good economic news out there, most recently illustrated by Friday's strong US jobs numbers. But, as the International Monetary Fund's Chief Economist, Olivier Blanchard noted last week, the acute risks facing the global economy have decreased, not disappeared.

* As an antidote to any hint of exuberance, here are three areas of risk identified by the International Monetary Fund (IMF).

* First, the IMF believes that euro area faces a growing risk of deflation, or a decline in the general price level. Inflation has fallen sharply across the region, and in Cyprus, Greece and Portugal prices are actually falling. Lower prices should help these economies regain competitiveness against the rest of the euro area. But a descent into deflation, or falling prices, across the euro area would be a serious threat to the prosperity of Europe.

* With euro area interest rates at just 0.25%, the European Central Bank has little scope to counter deflation with reductions in interest rates. The ECB would need, instead, to resort to the less predictable instrument of Quantitative Easing (QE). Indeed, a majority of respondents to an on-line poll in the Economist over the weekend expect the ECB to introduce QE this year.

* Deflation has a number of damaging effects. It drags down asset prices and raises the burden of debt and, in so doing, erodes household wealth and confidence. For very indebted governments, a rising real burden of debt can become unmanageable. Falling prices encourage consumers and corporates to delay spending to benefit from lower prices in the future.

* In its World Economic Outlook, released last week, the IMF makes clear that it sees deflation in the euro area as a growing risk to the world recovery.

* The second risk relates to emerging market economies. Easy money in the West bolstered growth and asset prices in emerging markets. China's equity market nearly tripled in value between late 2008 and late 2010. The slowing of the US Federal Reserve's programme of QE over the last year has been enough to hit emerging market equities and currencies hard. Commodity exporters, including Russia and Brazil, have suffered from the effects of falling energy, metals and raw materials prices. Meanwhile in the Middle East and Russia geopolitical risks are centre stage. Last week the IMF warned that the Ukraine crisis has already pushed Russia into recession. In China concern focusses on the risks posed by a sustained period of strong growth in credit, asset prices and investment.

* All these factors continue to weigh on prospects for growth in emerging markets. It is a sign of the time that the UK this year is expected to grow faster than two of the BRIC economies, Brazil and Russia. The IMF expects the Chinese economy to expand by 7.5% this year, an enviable rate by the standards of Western economies, but the slowest rate in a quarter of a century.

* The IMF's third worry is about the withdrawal of Quantitative Easing in the US. During the crisis the Federal Reserve pumped huge amounts of money into the US economy to increase liquidity, reduce interest rates and support asset prices. As the US economy heals this exceptional stimulus will have to be withdrawn. If the Fed acts too late credit and asset bubbles and inflation could take hold. If the Fed acts too early excessively tight monetary policy could derail America's recovery.

* Add in the technical uncertainties attached to unwinding such a vast programme of Quantitative Easing and the risks of unforeseen effects – seen, for instance, in the sell-off in emerging market assets when the Fed announced it was slowing its programme of QE – and the IMF's nervousness is understandable.

* The global financial crisis may be over. But it has created new challenges, be it the withdrawal of Quantitative Easing in the US or the spectre of deflation in Europe, which pose a continuing risk to growth. There's still enough risks out there to keep the International Monetary Fund awake at night.

MARKETS & NEWS

UK's FTSE 100 ended the week up 2.0%.

Here are some recent news stories that caught our eye as reflecting key economic themes:

KEY THEMES

* The US economy created 288,000 new jobs in April, the most since 2012 and much more than the 218,000 expected by economists

* Sterling rose to a 5-year high against the dollar following strong UK manufacturing data

* English National Opera announced that it is to branch out into musical theatre in order to help secure its financial future

* The International Monetary Fund (IMF) said that Russia is currently "experiencing recession" because of damage caused by the Ukraine crisis

* A 2-storey penthouse in One Hyde Park, London, became the capital's most expensive flat after selling for £140m

* The average British worker saw an 8% fall in real wages between 2008 and 2013, according to research from NIESR

* The European Commission forecast that France will miss its own budgetary targets for this year and the next

* Ratings agency S&P cut Mongolia's credit rating further in to "junk" territory – 2 years after the country raised $1.5bn through issuing its first Eurobond

* The Canadian finance ministry said that it is considering issuing a bond with a maturity of 50 years, subject to favourable market conditions.

* China has banned imports of British cheese after the country's food inspectors were dissatisfied with standards at a UK dairy

* Analysis by Scotiabank predicts that a one percentage point rise in UK interest rates over a year would knock around two percentage points off UK GDP

* The price of US crude fell below $100-a-barrell, due to booming oil production from shale rock formations

* eBay is to repatriate billions of dollars in cash it has been holding offshore, choosing to pay a large tax bill in the US in order to access funds it says it might need for deal-making

* Swatch, the world's biggest watchmaker registered complaints against Apple's applications for the trademark "iWatch", claiming it is too similar to the Swiss company's own "iSwatch"

* Chinese pork firm WH Group cancelled plans to float in Hong Kong, citing "deteriorating market conditions" – pulled pork

* A college in eastern France has refused North Korean requests to train 3 officials in cheese-making, in order to cater for the Emmental-loving Kim Jong-un – hard cheese.

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