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19/01/2006 | What Are the Upside Risks to the Global Economy in 2006?

WMRC Staff

While 2005 had its fair share of nasty surprises (bad weather, rising oil prices, etc.) the economic news was, by and large, very good. GDP growth in most parts of the world remained robust (and accelerated at the end of the year in weaker regions, such as the Eurozone), much higher oil prices did not translate into higher core inflation, and long-term interest rates stayed low.

 

Some of this was due to the fact that global monetary conditions continued to be accommodative throughout most of last year (even in the United States, where interest rates rose). The very favorable inflation environment also helped.

Looking forward, there is a chance that growth could continue to surprise on the upside, while inflation could surprise on the downside. Plausible assumptions about productivity growth, energy prices, inflation, and interest rates could produced a scenario for the coming year that is at least as good as that for 2005. Oil prices are a case in point. Global Insight expects oil prices to average between $58 and $60 per barrel this year, falling gradually to between $55 and $57 next year. However, a mild winter, high product stocks, conservation, and fewer disappointments in non-OPEC supply developments could lead to a more pronounced slide in prices. In an optimistic scenario, the WTI price could average between $45 and $50 in 2007. Milder weather in North America, Europe, and North Asia could also bring earlier relief from high natural gas prices.

In an optimistic scenario, U.S. economic growth could pick up to 4.2% in 2006 and stay above trend, at 3.7%, in 2007 (instead of the baseline forecasts of 3.4% and 2.7%, respectively). Sources of upside risk include faster productivity gains, stronger growth in business investment and exports, a softer landing for housing markets, and lower energy prices. If labor productivity growth holds near 3%, rather than decelerating, potential economic growth will be augmented and core inflation will remain subdued.

Similarly, Eurozone growth could prove to be more robust in 2006 than expected. One factor that could push growth up would be if the euro continued to trade around $1.20 or actually extended its downward trend of 2005, rather than moving back up (as Global Insight expects). A sharper drop in oil prices would also help European growth prospects. In addition, consumer spending could be significantly healthier than expected. There are currently limited signs that Eurozone labor markets are beginning to improve as the pickup in growth since mid-2005 forces more companies take on extra staff to deal with increasing workloads. If this trend persists, consumers might become increasingly willing, and able, to step up their expenditure. This could even lead to a virtuous circle, whereby higher consumer spending creates more jobs, leading to a further pickup in spending. In addition, there could be an element of pent-up consumer demand across the region, following extended subdued consumption.

A variety of factors could also come together to produce stronger growth in Asia. In particular, recent data show that China has been growing at a faster-than-expected rate in past few years (around 10% on average). As a result, Global Insight is in the process of revising up its 2006 growth estimate for the Chinese economy from 8.8% to around 9.4%. Other parts of Asia will benefit from continued strong growth in China, the United States, and other parts of the world. At the same time, conditions for robust growth

Author: Nariman Behravesh

Contact: Raul Dary

24 Hartwell Ave.
Lexington, MA 02421, USA
Tel: 781.301.9314
Cel: 857.222.0556
Fax: 781.301.9416
raul.dary@globalinsight.com

www.globalinsight.com and www.wmrc.com

WMRC (Reino Unido)

 



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