The tragic events in Japan have added to the growing concerns about the strength of the global economy but they should not push the world back into recession, finds the latest GPS Monthly report from CIBC World Markets Inc.
While it will take time before information is available to make a complete and accurate assessment of the implications of the events in Japan, both in human and economic terms, the report notes that the global economy was already facing increased uncertainty on a number of fronts.
“After riding some strong tailwinds late last year, the global economy finds itself buffeted by new and, in some cases, completely unforeseen developments,” says Peter Buchanan, senior economist at CIBC. “While the risk of outright recession would still appear to be quite low, those developments have led to a scaling back of earlier optimism and an increase, for now at least, in risk aversion.
“Surging gasoline prices raise questions about whether U.S. consumer spending can continue its healthier pace. With the focus on containing red ink, governments in the industrialized world are reaching for the spending ax. Moreover, monetary policy in last year’s hot performers-the emerging markets-is poised to tighten further, hampering growth as inflation tops official targets.”
Mr. Buchanan thinks that oil prices would have to reach $160 a barrel to derail the economy recovery, a scenario he does not see playing out.
“Oil has risen dramatically before, only to crash back to earth, and there are still good reasons why history may repeat itself. Industrial-country inventories were adequate when the Middle Eastern political pot began bubbling.
“OPEC likes firm prices, not sky-high, recession-inducing ones that crush oil demand, and the Saudi’s recent output hike suggest the cartel has at least some spare capacity, in contrast to the situation when oil spiked three years ago.”
He notes that strong but not sky-high oil prices are also best for the Canadian economy.
“The Canadian dollar followed crude north in the 2008 spike only until prices hit $100 a barrel. That would seem to suggest that for Canada the negative effects of costlier oil, like weakness in trading partners and auto sales, begin to increasingly outweigh producer rents once prices reach triple digits.”
Using a standard statistical modeling approach, Mr. Buchanan found that it takes about a year for the U.S. economy to feel the full pinch from an oil price shock. As Canada is one of the world’s top dozen net exporters of oil and oil products he found that in the near term higher crude prices are a modest plus for the economy. A 25 per cent rise in prices – roughly the recent increase – ordinarily lifts real GDP growth by a couple of ticks in each of the two following quarters.
Beyond a couple of quarters, the negative effects, including the drag on key trading partners and auto sales, begin to outweigh the positive, hurting GDP growth. Beyond four to five quarters, the bad more than cancels the good, and the level of GDP is actually lower than it would otherwise have been. A further negative is the increasing drag from the induced appreciation of the loonie on the country’s non-energy exports.
The report also notes that in addition to higher oil prices, global growth is also being dragged down by increased government fiscal restraint, particularly in the U.S.
“Although rising debt levels will result in dramatically higher interest payments over time, cutting spending sharply while the economy is still recuperating is not without risks,” adds Mr. Buchanan. “The blow from front-load spending reduction is one reason we expected the U.S. growth numbers to sport a two- rather than three-handle moving into 2011.”
The negative impact of oil price hikes and government cutbacks has seen CIBC’s forecast for 2011 U.S. GDP growth drop a tenth of a point to 2.7 per cent. Fiscal restraint will continue to be a drag on growth in 2012 as measures like the $120 billion social security tax cut expire. The Federal cuts will be further compounded by spending reductions by state governments.
Another risk to global growth is the fact that emerging market economies are likely to increase monetary tightening and other restraint measures to tackle inflation to ensure long-term price stability.
“That will cool performance in what, to this point, have been some of the world’s hottest performers. While those economies are unlikely to sink into recession, growth simply won’t surprise to the upside the way it has in recent years.”
While Canada is not immune to the economic issues facing the global economy the report forecasts Real GDP growth of four per cent in the first quarter of 2011. As a result, Mr. Buchanan expects a Bank of Canada rate hike in May.
The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/gps_mar11.pdf
CIBC’s wholesale banking business provides a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.
For further information: Peter Buchanan, Senior Economist, CIBC World Markets Inc. at (416) 594-7354, [email protected]; or Kevin Dove, Communications and Public Affairs at 416-980-8835, [email protected]