World economy: EIU’s global forecast – upgrading the US, downgrading emerging markets

Europe’s financial crisis will continue to weigh on the global economy in 2012, and still has the potential to cause disaster. There is little change this month to the Economist Intelligence Unit’s forecast for aggregate global GDP growth. We sharply lowered our euro zone forecast last month, and have not materially changed our view since then. In contrast, we think growth prospects in other regions – and their ability to weather the global slowdown – have changed in significant respects. Most notably, we have raised our forecast for US growth but have cut our forecasts for some emerging markets.

We expect world GDP to grow by 3.1% at purchasing-power parity in 2012. This marks a considerable slowdown from 2010 and 2011, and by some definitions would put the global economy perilously close to another recession. However, we reckon that growth would need to weaken to about 2% to qualify as a recession. While trading conditions have clearly become more challenging in many countries, the world is still quite some way from that bleak outcome. This assumes that implosion is prevented in Europe; a break-up of the euro zone remains a very real threat, and if that were to occur the global economy would suffer a recession much worse than the one recorded during the post-Lehman financial crisis of 2008-09.

Political bickering in Europe continues to hamper efforts to save the single currency. Policymakers haven’t done nearly enough to prevent further contagion, and the viability of the euro remains in question. We still attach a 40% probability to a euro break-up occurring within the next two years. The “fiscal compact” announced in early December looks unpromising, which matters not just for future economic governance in the EU but also because in the short term it may discourage the European Central Bank (ECB) from overcoming its reluctance to intervene more heavily in government bond markets. The ECB did take an important step in mid-December by boosting liquidity, but this welcome development was quickly followed by further bad news, including the decision by Standard & Poor’s to downgrade its credit ratings for nine euro members. Even if policymakers ultimately do enough to save the euro, which is still our core assumption, the process won’t be quick or painless.

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