Is the Global Economy in Danger of Overheating?

Source Oxford Economics

Executive Summary

The recovery in the world economy has been stronger than we expected a year ago, driven by the rebound in growth in emerging markets. The Asian trade boom, which kick-started the recovery in emerging markets, is now less dynamic than the heady pace of a year ago, but large domestic markets have insulated many emerging markets from the slow recovery in the advanced economies. And this strong pace of growth in domestic demand in emerging markets is expected to continue.

But the strength of domestic demand in emerging market economies also lies behind one of the most likely risks to the global economy. With the level of inflation already at uncomfortable levels, particularly within the BRICs, there is a significant risk of overheating in emerging markets. Under this scenario, global growth could slow by more than 1 percentage point next year.

The global shift towards inflation concerns has been exacerbated by sharp rises in commodity prices with oil now at $116 per barrel compared with $94 at the end of December. Our measure of the non-oil commodity price index has also risen sharply over the past six months and is now well above the peak in 2008.

The rise in commodity prices is a particular threat to emerging markets where commodities constitute a bigger proportion of production and consumption, and where capacity constraints are already tight. In contrast, the inflation threat in advanced economies is likely to be short-lived and an early tightening of policy there could derail the recovery.

The global dependency on oil has been highlighted by the developments in the MENA region. A further escalation of tensions in the Middle East would mostly impact on the global economy through higher oil prices and financial contagion. Under a crisis scenario where oil reaches $200 per barrel, global growth could slow by nearly 2 percentage points next year.

A Middle East crisis could also trigger the crystallisation of sovereign credit risks in the Eurozone. Recent weeks have already seen growing concerns in Portugal and Ireland, with a slew of further ratings downgrades. A full-blown Eurozone sovereign debt crisis, should it occur, would plunge the Eurozone back into recession and could halve global growth.

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Comments

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