Today, the IMF once again cut its 2015 global growth forecast from 3.8% to 3.5%. This downbeat sentiment reflects a turbulent 2014 which saw the unravelling of a number of key political and economic events. These have by and large served to dampen expectations for the global economy as we brace ourselves for another eventful year.
What happened in 2014?
During the course of 2014 several adverse developments took their toll on investor confidence and the steam off the global growth engine. The conflict in Ukraine sent shockwaves around the globe and led to heavy international sanctions on Russia. Continued strife in the Middle East underpinned persistent geopolitical uncertainty in the region and sparked fears over the stability of the global oil supply.
The Eurozone continued to battle with deflation and struggled for growth in the face of an upsurge in radical anti-austerity political parties in the European periphery. In Africa, the outbreak of the Ebola virus has been damaging to the already fragile economies of Western Africa. And key emerging economies, like China and Brazil, saw a slowdown in growth causing alarm to investors worldwide.
Despite this unfavourable backdrop, the UK economy showed resilience to grow strongly in 2014. Strong domestic consumption and the release of pent-up investment demand following years of under-investment have seen the UK emerge as the strongest performer in the G7 for 2014. Nevertheless, while the UK is predicted to grow healthily for 2015 the risks to growth are tilted on the downside. These risks are mostly concentrated on developments outside the British isle.
The year ahead
Much of the uncertainty about global growth prospects stems from the fact that 2015 is poised to be another busy year. Many of the 2014 risk factors have carried over to the year ahead; geopolitical uncertainty in the Middle East lingers, the Ukraine is in near-default and Russia is dipping into an EU sanction and oil related recession. Growth in major emerging economies continues to slow, with China recording its slowest growth in 2014 for 24 years.
For all the discouraging news items in 2014 there was one major positive; around mid-June the oil price plummeted and now stands more than 50% lower from its June price. The plunge in the oil price has sparked deflationary pressures across the global economy helping to boost production and allow central banks to maintain an expansionary monetary policy to support ailing growth. While the drop in the oil price has been positive on aggregate (oil & gas producers are not too happy) it has not been enough to reverse the negative momentum in the global economy.
What is more, deflationary pressures from the drop in energy prices are compounding the negative fiscal positions of indebted countries and in combination with weak growth this increases the probability of a rout in risky assets. The build-up of sovereign debt and fears over its sustainability will continue to be a key theme in 2015.
Risks for the UK
This brings us to potentially the largest risk to UK growth. The heavily indebted Eurozone is about to face another existential crisis. On Sunday, Greek citizens will go to the ballot with the radical left-wing party Syriza looking certain to win. By the end of the year, Spain, another ailing economy of the Southern periphery is set for elections where the anti-austerity party Podemos is gaining in strength.
While Syriza has toned down its anti-EU rhetoric and has dropped Grexit as its core policy, its pre-election demands for a debt write-off and retracting on structural reforms is placing it at odds with the EU’s power-broker, Germany. The election of Syriza creates a menu of possible scenarios for the future of the Eurozone from Grexit to outright breakup to reasserting the unity of the single market (further analysis on the Greek Election will be published on this blog on Friday 23 Jan).
What is certain however, is that the months succeeding the Greek election will be marred with renewed uncertainty and volatility in markets as SYRIZA attempts to form government and negotiations with the Troika commence. In contrast with troubles in the Middle East and Eastern Europe that mostly affect the UK indirectly, strong trade and financial links with the EU mean that developments in the Eurozone will have a direct bearing on the UK’s economic performance.
An existential crisis in the already struggling Eurozone means that the risk of another recession across the British Channel cannot be written off. In fact, with anaemic growth and deflation taking its hold, there is a range of circumstances that could trigger another shock in confidence in our European neighbours. As such, in EEF’s latest Exec Survey we modelled the potential impact of a loss in investor confidence reigniting a recession in the Eurozone against a set of key economic indicators.
While it would not drag the UK back into negative growth territory, the impact of a collapse in Europe in 2015 would be wide-ranging, and it would be sustained, with GDP growth coming in well below our baseline forecasts for each of the next three years. With our main overseas market struggling, export growth would be muted in 2015 and 2016, meaning growth in the export-intensive manufacturing sector dips considerably.
Under this scenario, output in manufacturing would end 2017 at 3.5 % below the level of our baseline. Recession in Europe would also hurt UK domestic demand through a reduction in businesses’ confidence to invest, and consumers’ confidence to spend.
All in all, another recession in the Eurozone has the potential to throw the UK’s economic recovery off track. The UK has to face its own dose of political upheaval as the General Election in May draws closer and the result remains highly uncertain. Still, it seems that the key risks to growth for 2015 will come from overseas.