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The latest forecasts from the Organisation for Economic Co-operation and Development (OECD) see global growth easing to 3.4% in 2012. This is down by one percentage point on its forecast a year ago, and similar to the IMF’s April forecast. However, QNB Group notes that risks of a Eurozone breakup and gloomy new global economic data point to an even worse outcome than the OECD forecasts. 

The OECD, a grouping of 34 of the most developed countries—including the US, Japan and most of the EU -released its latest twice-yearly economic outlook on May 22nd. The OECD forecast outlines a three-track global economy. It sees a mild recession in the Eurozone (contracting by 0.1% in 2012), weak growth around the 2% mark in most other OECD countries, led by the US, and about double that performance on average in emerging economies.

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A key reason for the differing performance between the Eurozone and the US is that, while both are undergoing fiscal austerity, there has been substantial private sector deleveraging in the US since 2008, enabling a pickup in private consumption, whereas in Europe there has been stagnation on both fronts. This is because the legal and cultural structures in the US are designed to enable more rapid corrections, draining the poison of the financial and housing crisis, however painfully, and then moving on.

The outlook assumes a scenario in which the Eurozone and the global economy broadly muddle along without a serious crisis. In particular, it assumes that there are no “destabilising developments” in the Eurozone over the next two years.

However, this scenario is challenged by a recent but growing consensus that a Greek exit from the Eurozone is now highly likely within the next year, possibly within months. On June 4th, Standard & Poor’s credit ratings agency assigned a 33% probability to a Greek exit, and even higher odds are implied on spread betting markets. The outcome of the Greek elections on June 17th may affect only the timing of this exit. An increase in the number of seats going to anti-bailout parties would increase the likelihood of an early exit, but the opposite result might only delay the event.

In addition, there are fears that Spain, with an economy five times larger than Greece, might also be forced to leave the Euro. On May 25th, Spain’s third biggest bank, Bankia, announced that it required a €19bn bailout. This increased concerns about government debt obligations and the health of the country’s residential property market, the main source of Bankia’s losses.

Finally, a slew of negative data over the last few weeks from beyond the Eurozone suggests greater weakness in other parts of the global economy.

In the US, job creation in May was sharply below expectations and the unemployment rate ticked up, after a period of steady decline, to 8.2%. In China, house prices continue to fall and the latest services sector data was the weakest in a year. More worryingly, India’s GDP growth fell to a nine-year low of 5.3% in the first quarter.

In response to the bad data and heightened risk-perceptions emanating from the Eurozone, equities have been falling and oil has slipped to its lowest level since January 2011, as the outlook for global demand has weakened.

On the policy front, the OECD report offered some suggestions for addressing the Eurozone woes. Firstly, it suggested that some of the resources of the European Stability Mechanism (ESM) should be used to recapitalise banks. The ESM is a €500bn rescue fund, with contributions from all the Eurozone members, and may start operations on July 9th, pending member state ratifications.

Furthermore, the OECD recommends jointly-guaranteed resources for the European Investment Bank, to stimulate growth through infrastructure investments. It says that this could pave the way for the issuance of Eurobonds—the mutualised debt instruments that some weaker Eurozone countries are advocating, but which Germany strongly opposes.

The OECD’s support for these policies adds an influential voice to the growing weight of opinion in their favour, but there is still no sign of their imminent implementation.

QNB Group expects that the Eurozone crisis, and its wider impact on the global economy, will continue to intensify in the coming weeks and the markets will remain jittery. Unless there is an unexpected turnaround in economic indicators, an improvement in sentiment is only likely in response to significant state interventions.

Indeed, the OECD report warns that, without policy action at both national and supranational levels, there is serious downside risk to its core scenario. Developments in the two weeks since the report was released have further highlight this downside risk.

There are a couple of key meetings in late June that could deliver such interventions. A G20 meeting in Mexico on June 18-19th, immediately after the Greek election, could lay the foundations for multilateral action to support the global economy. Then, a June 20th meeting of the US Federal Reserve might announce a third round of quantitative easing, boosting markets through the injection of cash. Finally, and most importantly, an EU summit on June 28th may make moves towards fiscal union and ease German opposition to mutualised rescue measures.


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