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Forward Thinking Magazine : April 2011
36 One of the conditions from 2010 that is expected to remain unaltered is the strong performance of emerging economies, compared to the large developed economies. But looking beyond the macro level will reveal greater internal differentiation within and between economic groupings. Because the divergence between the emerging and the developed economies has been in place for a number of years, there is now a temptation to assume that it will be business as usual for economies and asset markets. Yet beneath the surface there are some important changes underway and these have the potential to overturn the comfortable assumption that the past is just a prologue to the future. The most important development in 2011 is likely to be the increasing divergence within emerging and developed economies. Recent developments indicate that the most probable catalyst of this greater degree of internal diversity is the capacity of macro policymakers to successfully address rising inflation and cost of living pressures in their respective economies. The capacity of macro policymakers to manage economic activity will also be tested by the occurrence of several natural disasters, including the devastating floods in the Australian states of Queensland and Victoria, the second Christchurch earthquake in New Zealand and the earthquake, tsunami and subsequent nuclear crisis in north-east Japan. It is still too early to accurately gauge the full impact of the most recent natural disaster in Japan. But comparisons with the Kobe earthquake of 1995 suggest that Japan’s real GDP growth rate could be cut by 0.25-0.5 per cent in 2011 and then boosted by at least 0.5 per cent in 2012 as reconstruction takes place. Although growth in the emerging economies is expected to remain firm in 2011 there will likely be considerable variation in terms of growth and inflation outcomes between economies. India is expected to grow just as strongly as it did in 2010, while growth in China should ease, but the slowdown is expected to be modest. A more notable slowdown is expected in Brazil, although the rate of growth should still be high by the standards of the developed economies. Policy changes such as different official interest rate settings partly explain this dispersion. But some of the variation is also due to exchange rate shifts. For example, the strength of the Brazilian Real compared to the Chinese RmB is just one reason for the expected divergence in growth rates. Growth conditions in some developed economies will improve noticeably in 2011, but in others the deflationary impact of unemployed resources will continue to burden economic performance. Importantly, signs of recovery in the US economy continue to accumulate, suggesting that the economy will be growing at a rate in excess of its long term potential by the end of 2011. In the Euro region, Germany continues to be a source of strength and financial stability, which is providing some offset to the pronounced weakness in the euro-periphery economies. In the UK, the fortunes of the economy in 2011 still hang in the balance and they will depend on the judgement of macro policymakers in embarking on an ambitious program of fiscal consolidation. Should the incidence of the budget expenditure cuts prove to be deflationary, then the economy’s track towards recovery will be severely impeded. Interestingly, one of the most variable economies in 2011 is expected to be the Australian economy. Following a year of resilient expansion in 2010, Australia now faces a considerable shift in economic fortune, partly reflecting the impact of recent natural disasters. Early and decisive monetary policy tightening by the Reserve Bank of Australia has also played a role in curtailing some of the rapid expansion in domestic demand. Overall, it is expected that the impact of the recent natural disasters will reduce real GDP growth by 0.5 per cent in 2011 and increase consumer inflation by 0.5 per cent over the same period. The rapid and unforeseen reduction in Australia’s growth rate is expected to prompt the Reserve Bank to leave official interest rates unchanged for at least the next 3-4 months. Needless to say, the medium term outlook for Australian interest rates will in large part depend on whether the boost to inflation due to the impact of the tragic Queensland and Victorian floods and Cyclone Yasi proves to be a one-off price effect. From a global perspective, asset markets are expected to adopt a pro-growth and inflation bias, meaning that those economies coming off a low growth base will see high demand for their assets. Economies and asset classes prone to inflation risk will underperform in 2011, in some cases leading to a rapid reversal of the gains recorded in 2010.