Key Points
- Policy-makers have raised hopes that the worst of the credit crisis might now be behind us. And recent data has been more positive generally, but particularly in the US.
- However we remain cautious. We note that while credit pricing does indeed seem too extreme, especially in the US, the two most obvious signs of recovery: a more normal interbank spread; and stabilizing house prices, remain conspicuous by their absence.
- All of our GDP fan charts are therefore negatively skewed, with the UK the most skewed to the downside.
- The risk of a full-blown UK recession has risen further in our view, and now stands well above 40%.
- By contrast, inflation forecasts are skewed to the upside, particularly for the Euro Area. The key factor here is the risk of second-round effects, to which within the G4 we feel Europe is particularly vulnerable.
Inflation is expected to exceed real growth everywhere but Japan. That leaves us in the uncomfortable position of forecasting a high risk of both recession and well above-target inflation. In our ‘misery league’, the combination of unemployment and inflation, the UK and the US share the dubious honour of pole position.
- However, we do not expect G4 central banks to repeat the mistakes of the 1970s. Real rates are expected to stay positive. That may add to short-term downside growth risks, but it will also lean against a repeat of the 1970s. Of greater concern to us are emerging economies given the lack of a credible nominal anchor in many cases.
Our asset allocation reflects these concerns. We go significantly underweight equities in this forecast; though we favour non-G4 equity markets where we feel the pendulum has not yet swung fully against growth.
- However, the upside for bonds is capped by inflation concerns – reasserting a more familiar positive correlation. Cash therefore remains king. By country, we prefer UK and European cash and bonds, to their American and Japanese counterparts.
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