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The global economy is looking healthier this spring than it did last year, when many analysts were predicting a breakup of the Eurozone. Markets have rebounded, particularly in the US which is showing positive signs of recovery, and forecasters are steadily revising up their expectations for global growth. However, new threats have emerged which could dampen the optimism, mainly around a possible slowdown in China and high oil prices, according to analysis from QNB Group.

The improved outlook for the Eurozone is due to two main factors which have mitigated fears of the breakup of the monetary union and a painful recession in 2012.

Firstly, the concern has receded that Greece might default on its debt in a disorderly way and trigger contagion in Italy and Spain. Greece faced a mountain of debt maturing in mid-March, but secured support to meet these obligations and its proposal to restructure its commercial debt was accepted by the majority of creditors.

Secondly, liquidity concerns in the Eurozone banking system were eased by a second massive injection by the European Central Bank of over €500 billion in cheap 3-year loans in February. This was on top of a similar amount already provided in December, taken up by a large number of financial institutions across Europe. Moreover, the banks have used part of the loans to buy sovereign debt, bringing down yields and reducing national borrowing costs.

Meanwhile in China, it has long been clear that the spectacular growth rates achieved over the last decade could not continue indefinitely. The question has been when the slowdown will come, how sharp it will be and what reverberations it will have on the global economy.

China hardly faltered in 2009, as domestic demand picked up the slack from a fall in exports, but since then concerns have been focused on China’s manufacturing, construction and real estate sectors.

A preliminary reading of HSBC’s China Manufacturing Purchasing Managers Index, a key lead indicator, fell for second consecutive month to 48.1 in March. Survey readings below 50 indicate a contraction. The Index has been hovering around 48-50 since July 2011, indicating stagnation but not yet a crisis. If it were to move decisively lower, say to 46, this could be a signal of serious problems, according to QNB Group.

The construction sector and real estate prices have surged since 2009, helped by a government-induced expansion in credit designed to reduce the impact of the global crisis. A slowdown in credit growth could lead to a sharp fall in property prices, resulting in defaults and undermining investment in new construction. 

To mitigate these concerns, the government has been dampening property speculation, including through limits on the number of houses individuals can own. The latest data showed that prices for new homes fell in 45 out of 70 major cities in February, the fifth month in a row that the majority of cities have seen small price falls. The aim is to cause the property bubble to gradually deflate, rather than bursting dramatically.

An encouraging economic sign has been an easing in the rate of inflation from 6.1% in September to 3.2% in February. This suggests that overheating within the Chinese economy is abating. It also gives the government more room to ease policy and support the economy if conditions deteriorate.

Separately, there are concerns that high oil prices could stifle growth in China and globally. Oil achieved a record average price in 2011 of US$111 per barrel and has increased since then to around US$119 in the first quarter of 2012. Prices are currently at the highest level since the spike in mid-2008.

The recent rise in oil prices is largely related to a political risk premium. The imposition of tighter sanctions on Iran and geo-political tensions have increased concerns about oil supply. This has added a risk premium of around US$15-20 to the price of a barrel of oil.

If oil prices remain at current levels or increase further, this could boost inflation around the world and divert resources from productive investment. This could undermine the fragile economic recovery in the US, deepen recession in the Eurozone, possibly reigniting the sovereign debt crisis, and trigger a sharper slowdown in China.

High-oil prices naturally benefit oil producing countries in the MENA region in the short term. However, if they significantly dent global growth, and hence oil demand, then there is a risk of a period of low prices in the future—as happened in 2009. This is unlikely to occur as a number of OPEC producers have said they would be content with an oil price at about US$100 per barrel and are willing to take measures to increase supply towards that end.


 

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