Risks remain for recovery

Apr 21 2010 by Andrew Miller, The Journal

THE good news is that, ash notwithstanding, the global recovery is continuing. The bad news is that markets have begun to focus on countries' fiscal burdens sooner than we had suspected they would.

Markets are now beginning to fear that other euro-area governments may face the same sort of problems as Greece.

And, were other governments forced to follow the Greeks down the sharp fiscal tightening route, they too could go back into recession.

The US illustrates the complexities involved. US GDP is currently probably expanding at a rapid rate, but we expect this growth to slow. The recent surge in US export growth is unsustainable, particularly in the wake of dollar appreciation.

And when it comes to prospects for US consumer spending, the outlook for the three key factors - the state of the labour market, fiscal policy and asset prices - is not problem free.

We expect a small rise in US employment, but a fall in real wages.

Moreover, household incomes aren't likely to be boosted to the same extent by fiscal transfers as in 2009.

In addition, the only hesitant rise in US house prices – a major asset for most people – may discourage US consumers from splashing out, despite gains they may have made in the equities markets.

And, as regards investment, firms clearly will want to use up existing spare capacity before they start investing again.

The US story – of recovery continuing this year, and at a slightly faster rate than looked likely at the turn of the year - can be told in Asia too. Economists have been making upward revisions to their forecasts for most countries in the region since the end of last year.

This does not imply, however, that the Asia story is one of universal good news.

There are two clouds in the sky.

First, Asian countries still remain heavily dependent on consumer demand in the US, UK and other developed economies.

This is something that may not be sustainable.

Second, inflation pressures are rising across the region, largely due to overly strong demand.

We don't expect either of these factors to derail the Asian recovery in the short term, although Sino-American relations (notably over exchange rate policy) could still boil over.

Other problems are closer to home, with Europe clearly the weakest link. Recent European growth data has been disappointing and sovereign risk is on the rise.

The cost to Greece of the new arrangements for its rescue has been a second, sharp set of fiscal adjustments – something that is almost bound to lead to it suffering another severe decline in GDP (perhaps of the order of 4%).

More worrying, from a Europe-wide perspective, there seems little to stop other EMU countries from suffering a similar fate. So while our central scenario remains one of sluggish global recovery, risks to this scenario remain.

Andrew Miller is head of the Newcastle office of Barclays Wealth