On 21 January 2015, the International Monetary Fund (IMF) updated its global economic growth and inflation forecasts given four key developments since the last release in October 2014: lower oil prices, growing economic divergences among advanced economies, US dollar appreciation, and movements in interest rates and credit spreads in emerging economies. As a result, the IMF is forecasting global economic growth of 3.5% in 2015 (was 3.8%) and 3.7% in 2016 (was 4.0%).

The IMF has also adjusted its forecasts of inflation given the dramatic fall in the price of oil over recent months, but it seems likely that further adjustments will be necessary as the full impact of lower oil prices are realised. This means that the shape of the world economy could be very different in 2015.

In Europe, where the main source of downside risk is held, the IMF is forecasting growth of just 1.2%. The real concern though is deflation (ie the general level of prices falling), especially given the sharp fall in oil prices. As a result, European Central Bank President Mario Draghi has taken decisive action in late January to fight deflation and provide an aggressive policy response by buying European government bonds. Simply, Europe is now undertaking what the US did from 2009 to 2014.

The performance of the Japanese economy was one of the biggest disappointments of 2014. The weak growth outlook in Japan is expected to see the Bank of Japan keep interest rates near zero and continue with aggressive quantitative easing programs in 2015. China’s growth rate is likely to moderate to an average of 7% per year in 2015, down from 7.3% per year in Q4 2014. Growth in China over 2015 is expected to be driven by an improvement in exports and relatively steady growth in consumption. This should offset a further slowdown in investment – especially related to the property market.

Lower oil prices is good news for oil importing countries that have a large consumer sector, which includes not only the US, Europe and Japan, but also countries like Australia. The lower oil price is bad news for energy exporting nations, such as those in the Middle East and Russia.

In addition, one of the defining events for global markets in 2015 is expected to be the start of the monetary policy normalisation process in the US, through the first interest rate hike. This is anticipated to occur around mid-year.

Political risks are also high on the agenda for 2015. The newly elected left-wing government in Greece, will be looking to renegotiate its official bailout program with EU officials in the coming months, once again reigniting speculation of a possible Greek exit from the European Union (a very unlikely outcome). There is a UK general election in May and elections in Spain late this year. In the US, the focus will turn to the 2016 Presidential elections and who will run.

In Australia, the outlook is most likely for a year of growth a bit below trend of just under 3%. The economy is slowly trying to rebuild momentum post the years of mining-led growth, but this is taking time. The Reserve Bank of Australia cut interest rates to 2.25% from 2.5% in February 2015 to provide extra support to the economy as it transitions from mining led growth to non-mining led growth, led by export growth in liquefied natural gas, education and tourism as well as the benefits from a lower Australian dollar.

Despite solid global economic growth, low inflation and central bank action is likely to keep global bond yields relatively low, although some increase should be expected from these ultra-low levels. Relatively low bond yields should be supportive of some share markets but there remains headwinds in the economic outlook globally. The US dollar is expected to be the strongest of the major currencies this year, especially against the Euro and the Yen. It should also be expected that volatility throughout financial markets should rise.

Article sourced via © Colonial First State