Revised Forecast for the US and European Economies in 2008-2009
- In the wake of the bursting of the asset bubble and rise in natural resource prices, the US economy heads for recession in early 2009 -
June 25, 2008
The steady worsening of the turmoil in the world's financial markets triggered by the subprime crisis ceased in mid-March this year, but the risk remains that the crisis will flare up again. In the real economy, the United States is experiencing a continuing adjustment in the housing markets. Against this backdrop, deteriorating employment and the rising price of gasoline have exerted further downward pressure on consumption and the US economy has remained sluggish. In the Eurozone and the United Kingdom, inflation and slower growth in housing prices have made the deceleration in consumption more apparent.
Given these conditions, the Macroeconomic Research Center examined the following three factors, which hold the key to the outlook for the US and European economies in 2008 and 2009.
(1) The impact of higher crude oil prices
The rise in the price of crude oil has come against a background of rapid growth in demand from developing countries and the long-term pressure on supply that this has occasioned, but its main cause is deteriorating confidence in the dollar. In a scenario where a weaker dollar means higher crude prices, as long as the downward trend of the dollar remains unchecked, the upward trend of crude oil prices is also likely to continue.
The rise in the price of crude oil has led to deterioration in trade conditions, which is impacting on corporate earnings and exerting downward pressure on capital investment. In the household sector, too, the fall in real purchasing power has curbed consumption. In the United States, which has a high crude oil consumption ratio, crude prices in excess of $100/barrel have brought an increased risk of economic recession. In the Eurozone, some countries, especially Germany, are likely to enjoy substantial growth of exports to the Middle East and Russia, which is expected to soften the negative impact to some degree. Although the rising prices of crude oil and food have led to rising inflation across the world, globalization is helping to reduce the upward pressure on wages, and core inflation rates have remained stable at a low level. Given that the scenario of higher natural resource prices and intensifying competition on the product supply side that has emerged since the year 2000 against a backdrop of faster growth among the developing countries is growing stronger, it is likely that the developed countries will continue to see wage stagnation and higher natural resource prices for some time.
(2) The trend of the US economy following the bursting of the asset bubble
In the past, when Northern Europe and Japan suffered large-scale economic adjustments following the bursting of their respective asset bubbles, severe capital stock adjustments resulted in economic growth lower than the latent growth rate for a period of over three years. A weakening of local currencies helped to bolster the Northern European economies; a rise in the value of the yen forced Japan into the deflation trap.
In the United States, the pressure for capital stock adjustments is limited, and the fall in the value of the dollar and the growth of the developing countries are helping to underpin exports, with the result that a major economic downturn is likely to be avoided. Meanwhile, the US household sector in the US is facing unprecedented pressure for balance sheet adjustments. The excessive debt that has become apparent in conjunction with the fall in housing prices means that household consumption must inevitably be sluggish in the short term.
The pattern of economic recovery in the United States runs "recovery in housing investment → recovery in consumer spending → improvement in employment and capital investment". As housing investment is unlikely to bottom out before the end of 2008, housing prices are not expected to bottom out before the second half of 2009. Consequently, for the next two years or so, consumer spending is set to stagnate and the economy is unlikely to see a full-scale recovery.
(3) The risk that Europe's housing bubbles will burst
In France, Spain and the United Kingdom, real housing prices have risen still higher than in the United States. The fact that consumption has risen on the strength of the rise in housing prices means that if housing prices begin to fall in future, there is a risk that the reverse wealth effect will cause a further slowdown in consumer spending. In the United Kingdom, the conversion of capital gains on housing to cash through borrowing has made the excessive debts of the household sector apparent and it is possible that the stagnation of consumption will be prolonged.
The Eurozone has seen excessive borrowing in comparison with the economic reality, and in the countries on the periphery of the Eurozone and the United Kingdom there has also been a sharp rise in real estate-secured lending. If the adjustment in housing prices goes any deeper, there is even a risk of a financial system crisis with its epicenter in Europe.
In the United States, the negative chain reaction of financial unease followed by economic deterioration and a weaker dollar coupled with higher crude oil prices is beginning to take effect. Although the administrative authorities have put forward appropriate countermeasures, these lack force and as the effects of the tax reductions tail off, it is likely that the negative chain reaction will grow yet stronger. The economic outlook is as follows.
Crude oil prices
With the dollar remaining weak in reflection of the stagnation of the US economy, crude oil prices are likely to continue to rise into late 2009.
The US economy
Owing to the adjustment in the housing markets and the decline in real purchasing power due to the rise in crude oil and food prices, among other factors, and with the benefits of economic stimulatory measures tailing off, the US economy is likely to slip into negative growth in late 2008/early 2009. From the spring of 2009, although the downturn will be halted as stimulatory measures put in place by the new administration take effect and housing investment bottoms out, consumption will remain sluggish and the pace of recovery is likely to be slow.
In the Eurozone, economic deceleration is likely to continue for some time against a backdrop of slower growth or falls in housing prices and higher inflation rates, but exports to natural resource-producing countries will play an underpinning role and it is likely that a major economic deceleration will be avoided. In the United Kingdom, owing to the fall in housing prices and resulting increase in the pressure to repay loans, growth is likely to remain slow, especially in consumer spending.
The danger is that international cooperative systems designed to stabilize the dollar will falter. If the sizeable interest rate increases in countries other than the United States cause the weakening of the dollar and the rise in the prices of natural resources to accelerate, there is a risk that the developed countries in particular will fall prey to a severe economic recession.
For more information on the content of this report, please contact Takeshi Makita, the Japan Research Institute, Limited.