December 2015
For professional investors only
Schroders
Economic and Strategy Viewpoint
Keith Wade
Chief Economist
and Strategist
(44-20)7658 6296
Global update: the square root recovery continues (page 2)

We have trimmed our forecast for global growth to 2.6% for 2016 from 2.9% as
although global demand has held up, there is little momentum and still some
signs of excess inventory to clear. The benefits from lower oil prices will continue
to support consumer spending, but inflation is set to rise and the oil dividend
fade in 2016.

Meanwhile, monetary policy is set to diverge with the US and UK tightening
whilst policy eases further or remains loose in the Eurozone, Japan and China.
Scenario risks are tilted toward the downside, raising questions about the ability
of central banks to respond to adverse shocks.
Azad Zangana
Senior European
Economist and
Strategist
(44-20)7658 2671
Craig Botham
Emerging Markets
Economist
(44-20)7658 2882
European forecast update: downgrades for 2016 (page 8)

Growing external risks have prompted the European Central Bank (ECB) to
consider adding further stimulus. Growth, while slightly weaker than expected, is
still consistent with a reduction in excess capacity, and therefore an eventual
recovery in inflation. Our growth forecast for 2016 has been downgraded to a
similar performance to 2015, although we then see growth picking up in 2017. As
for the ECB, we think QE will eventually be extended, albeit to have a limited
impact on the economy.

The UK is showing greater signs of spare capacity diminishing, highlighted by
the recent surge in imports. Growth appears to be slowing faster than previously
expected as austerity efforts are stepped up. We have downgraded our growth
and inflation forecast for 2016, which should delay the first Bank of England rate
rise, and also limit hikes as the economy slows further in 2017.
EM forecast update: an uneven recovery (page 14)

Further downgrades for emerging market growth as politics generates further
disappointments in India and Brazil. Our China view is little changed – a multiyear slowdown looks to be in progress
Views at a glance (page 20)

A short summary of our main macro views and where we see the risks to the
world economy
Chart: Global growth outlook
Contributions to World GDP growth (y/y), %
6
5.0 4.6 5.1 5.2
4.9
5
3.7
4
3.0
2.6
3
2.3
Forecast
4.7
3.5
2.6 2.5 2.7 2.5 2.6 2.8
2
1
0
-1
-1.0
-2
-3
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17
US
Europe
Japan
Rest of advanced
BRICS
Rest of emerging
World
Source: Thomson Datastream, Schroders Economic Group. 20 November 2015. Please note
the forecast warning at the back of the document
December 2015
For professional investors only
Global update: The square root recovery continues
Summary
Growth forecast
trimmed for 2016
We have trimmed our forecast for global growth to 2.6% for 2016 (previously
2.9%) as a result of modest downgrades to the advanced economies and
emerging markets (EM). Although global demand has held up in the second half
of 2015, there is little momentum and still some signs of excess inventory to
clear. The benefits from lower oil prices will continue to support consumer
spending but inflation is set to rise and the oil dividend fade in 2016.
For the emerging economies, China continues to decelerate in 2016, but signs of
stability in Russia and Brazil will result in a better year for the BRIC’s. The global
growth forecast for 2017 is 2.8%, with growth moderating in the advanced
economies in response to monetary tightening in the US whilst EM growth is
marginally higher.
Inflation is expected to pick up in 2016 as the base effects from lower commodity
prices drop out of the index. Global inflation rises to 3.7% in 2016 from an
estimated 3.1% in 2015, led by the advanced economies which see a pick-up of
around 1 percentage point. For EM, inflation also picks up in China and India, but
the aggregate moderates as currencies stabilise.
The US Federal Reserve (Fed) is expected to look through the current low
headline CPI rate and focus on a firmer core rate of inflation and tightening
labour market so as to raise rates in December 2015. We previously expected a
March 2016 lift-off, but having shifted the goalposts by dropping their concerns
about China at the last meeting, we now see little reason for the Federal Open
Market Committee not to move in December. More important than the date of the
first rate rise is the profile of rates and we expect the Fed funds rate to rise to
1.25% by end 2016 and 2% by end 2017, where it peaks.
We look for the European Central Bank (ECB) to extend quantitative easing
beyond September 2016 and leave policy rates unchanged until the end of 2017
when we expect the first hike. For the UK, we expect the first rate increase in
August 2016 (previously May) as inflation stays lower for longer. In Japan, the
Bank of Japan will keep the threat of more quantitative and qualitative easing
(QQE) on the table, but is now likely to let the weaker yen (JPY) support the
economy and refrain from further loosening. China is expected to cut interest
rates and the reserve requirement rate (RRR) further.
Overall global growth of 2.6% is little changed from the 2.5% estimated for 2015
and confirms that the “square root recovery” where growth has been around
2.5% since the rebound in 2011, continues as the new normal.
Looking back at 2015
For the fifth year
running
economists were
too optimistic
about global
growth
2
Although the year is not over, it is clear that 2015 is set to be another where
global growth has disappointed. The latest estimates suggest that the world
economy is likely to have grown by 2.5% this year compared to forecasts of 3% a
year ago. The figures for the US show that this will be the fifth year running that
growth has undershot expectations (see chart 1). The pick-up in growth has not
materialised and economists are in danger of meeting Albert Einstein’s definition
of insanity: doing the same thing over and over again and expecting different
results.
December 2015
For professional investors only
Chart 1: US growth disappoints…again
Consensus US growth (y/y%)
3.5
3.0
2.5
2.0
1.5
1.0
2010
2011
2011
2012
2012
2013
2013
2014
2014
2015
2015
2016
Source: Thomson Datastream, Consensus Economics, Schroder Economics Group. 20
November 2015.
We are not wholly exempt as our forecast for global and US growth was 2.8% a
year ago. Although we were aware of the risk of being persistently too optimistic,
we believed that the world economy would be lifted in 2015 by the fall in oil
prices. As it turned out, oil prices and inflation were even lower than expected a
year ago, but growth still undershot.
Overall benefit of
lower oil price
muted as losers
cut back hard
Looking at the breakdown between the advanced and emerging economies,
much of the miss on growth was in the latter, indicating that the losers from lower
commodity prices reacted more aggressively than the winners in changing their
expenditure patterns. Pressure on EM has also come from the expectation of
higher US interest rates and a rise in the US dollar. Inflation has been higher in
many emerging economies as a result of currency devaluation following capital
flight, and this has added to the squeeze on their real incomes and growth.
Emerging markets account for just under 38% of the world economy so their
slowdown accounts for a significant portion of the undershoot in global growth.
From the US perspective the growth shortfall was not from the consumer side,
where spending has accelerated to a 3% pace as expected. Lower energy prices
have helped the consumer as they have elsewhere. Instead, the disappointment
has come from capex which was expected to grow by 6%, but is now forecast to
record just 3% growth in 2015. The breakdown shows that the weakness can
largely be attributed to cutbacks in the energy sector which have dragged on
fixed investment in structures and equipment.
So the explanation for the undershoot in the US is also a case of the losers
cutting back and offsetting some of the higher spending by the winners. It marks
a change in the US economy which reflects the increased importance of oil
following the development of shale gas production.
3
December 2015
For professional investors only
Chart 2: US capex and consumption expectations and outturns for 2015
%, Y/Y
6.5
%, Y/Y
3.6
6.0
3.4
5.5
5.0
3.2
4.5
3.0
4.0
3.5
2.8
3.0
2.6
2.5
2.0
Jan 14
Jul 14
Jan 15
2.4
Jan 14
Jul 15
Jul 14
Jan 15
Jul 15
Personal consumption consensus forecast 2015
Personal consumption expenditure
Business investment consensus forecast 2015
Private domestic fixed investment
Source: Thomson Datastream, Consensus Economics, Schroder Economics Group. 20
November 2015.
In the developed world it was not just growth which came in below expectations,
but also inflation. Chart 3 shows the downward evolution of US CPI forecasts for
the past three years. For 2015, this largely reflected the weakness of the oil price
which failed to recover in line with the path predicted by the futures market (our
baseline assumption).
Chart 3: US inflation forecasts by year
Inflation has also
undershot
Consensus US inflation (y/y%)
2.5
2.0
1.5
1.0
0.5
0.0
2012
2013
2013
2014
2014
2015
2015
2016
Source: Thomson Datastream, Consensus Economics Schroder Economics Group, 20
November 2015.
Combining the growth and inflation forecasts it is clear that expectations for
nominal GDP have fallen short in 2015 as they have done since 2012. The
important point is that this is symptomatic of a world where there is a shortage of
global demand. Combinations where both growth and inflation over or
undershoot in the same direction tend to be demand driven, whilst those which
move in opposite directions are supply related. For example, stronger growth and
lower inflation reflects productivity led growth, whilst weaker growth and higherthan-expected inflation suggests the economy is hitting capacity constraints.
The direction of the errors suggests that a mix of demand deficiency and excess
global supply characterise global activity. On the demand side, the weakness of
investment spending accounts for part of this, but economists have also
4
December 2015
For professional investors only
overestimated the gains from exports and trade by assuming that demand from
overseas will be stronger. Unfortunately with many economies going through the
same adjustment post the global financial crisis this has not been the case, as
can be seen from the persistent weakness of global trade volumes (chart 4).
Chart 4: Global trade, still waiting for the upswing
Undershoot on
growth and
inflation points to
mix of demand
deficiency and
excess global
supply
%, Y/Y
25
20
15
10
5
0
-5
-10
-15
-20
92
94
96
Recession
98
00
02
04
06
World export volumes
08
10
12
14
Average trade growth
Source: Thomson Datastream, Schroder Economics Group. 20 November 2015.
Outlook: headwinds and tailwinds for 2016
The persistent over-optimism about global growth raises deep questions about
the state of the world economy and tempers enthusiasm for predicting an
improvement in 2016. Given the above analysis, the key question is whether
demand will strengthen in 2016?
Looking at three key areas, it is difficult to see much in the way of extra stimulus
in 2016:
1. Commodity prices. Lower energy prices were meant to boost growth in 2016,
but as we have seen this has been a mixed bag for overall global activity.
Nonetheless, at current oil price levels it would seem that energy related capex is
stabilising in the US and so will not be as big a drag as in 2015. However, the
rise in CPI inflation will begin to cut into real income growth and slow consumer
spending. Unless we see a desire to increase borrowing (and push the savings
rate lower) consumer spending growth will slow in 2016.
Commodity
prices will be
less of a tailwind
for the consumer
At a broader level we have seen how the decline in commodity prices has hit the
emerging markets. There may be some stability in prices in 2016 allowing growth
to recover. This is our baseline view; however, we may also see second round
effects from the commodity price collapse as the cash flow problems created by
the fall in metals and energy lead to restructuring and cut backs. Many producers
may be hanging on for a recovery in prices which has not materialised, or have
been hedged up to this point. Consequently, 2016 could be a year of reckoning
for many commodity countries.
Of course those with strong balance sheets can endure the storm and we are
seeing the likes of Saudi Arabia dip into their sovereign wealth fund and now
issue bonds. Not everyone can do this though and the weaker countries may find
life difficult in coming months, unless we see a bounce in energy and metals
prices. We have included a scenario to capture this risk (EM default). On balance
we see commodities as more of a neutral factor for the world economy in 2016,
having been generally positive in 2015.
5
December 2015
Monetary policy
becomes
restrictive in the
UK and US, but
remains loose
elsewhere
For professional investors only
2. Monetary policy. Divergence remains the key theme. For the US and UK
monetary policy is set to become more restrictive as interest rates rise. We now
expect the US Fed to raise rates in December given the recent change in tone
from the FOMC. US rates are expected to rise slowly to 1.25% by year end 2016,
with a pause in the run-up to the Presidential election next November.
Elsewhere though, there have been a series of monetary policy measures which
will help growth such as rate and reserve requirement cuts by the PBoC.
Continued, or increased, QE in the Euro-area and Japan will also provide some
support, but primarily through the EUR and JPY, so will help their domestic
economies rather than boost global activity. The USD and Chinese yuan (CNY)
will remain strong and so should continue to exert a deflationary influence on the
US and China as a result.
3. Fiscal policy. Canada has decided to use fiscal policy to boost growth
following the election of Justin Trudeau as Prime Minister, a possible indication of
a more general swing in the political mood after frustration with the growth in the
economy. It is likely that we get some easing of US fiscal policy next year, led by
higher defence spending and China is set to provide fiscal stimulus. Policy in the
Eurozone may also be marginally supportive, largely driven by spending on
migrants in Germany. By contrast the UK is tightening policy. Overall fiscal policy
will be marginally expansionary.
Overall, this results in a reduction in stimulus as the boost from commodity prices
fades. For the US, Fed tightening and the strong USD will act as headwinds on
activity next year. The UK also faces headwinds from higher interest rates, but
also from fiscal tightening. Easier monetary policy supports the Eurozone, Japan
and China, whilst stability in commodity prices helps the EM exporters (see
table 1).
Table 1: Growth scoreboard for 2016
US
Eurozone
UK
Japan
China
EM
commodity
exporters
Interest rates/QE
–
+
–
+
+
–
Exchange rate
–
+
0
+
–
+
–
0
+
0
Monetary
Fiscal
+
Commodity prices
0
0
0
0
0
0
-1 (+1)
+2 (+3)
-2 (0)
+2 (+3)
+1 (+2)
0 (-1)
Net
Source: Schroder Economics Group, 20 November 2015.
Scenarios: enter FX wars and EM default risks
Scenarios now
include a
resumption of the
FX wars
We have made a few changes this quarter adding ‘FX wars’ (RMB devaluation
triggers a series of devaluations), ‘Middle-East melee’ (higher oil price), ‘US
wages accelerate’ and ‘EM defaults emerge’. Out go ‘bad Grexit’, ‘oil lower for
longer’, ‘Fed behind the curve’ and ‘Tightening Tantrum’. Note that US wages
accelerate is similar to Fed behind the curve and EM defaults compares to
tightening tantrum. There is still a risk of a ‘bad Grexit’ but it has been
considerably reduced as a result of the bailout agreed earlier in the year. Having
said that, we could well see Greece return to the headlines in the New Year
when the IMF has to decide whether to continue to support the programme.
Full descriptions of each scenario and their implications can be found on page
20. As can be seen from chart 5, the risks are still skewed toward deflationary
outcomes i.e., weaker global growth and inflation.
6
December 2015
For professional investors only
Chart 5: Scenarios around the baseline
2016 Inflation vs. baseline forecast
+1.0
Reflationary
Stagflationary
Middle-East
melee hits oil
+0.5
Global
reflation
US wages
accelerate
+0.0
Currency wars
return
Baseline
US recession
-0.5
China hard
landing
EM defaults
emerge
Productivity boost
Deflationary
-1.0
-1.5
-1.0
-0.5
+0.0
+0.5
2016 Growth vs. baseline forecast
+1.0
+1.5
Source: Schroder Economics Group, 20 November 2015. Please note the forecast warning at
the back of the document.
In terms of the balance of probabilities, the mix of scenarios has moved in a more
deflationary direction with an increase in probability compared to last August.
This largely reflects the relatively high probability (10%) attached to the EM
default scenario. The productivity boost outcome has fallen to zero as a result of
dropping the oil lower for longer scenario. Stagflation has increased as a result of
the inclusion of the higher oil price scenario, Middle East melee.
Table 2: Balance of probabilities by scenario outcome vs baseline
Balance of risks
remains tilted
toward deflation
Scenario
Deflationary
Reflationary
Productivity boost
Stagflationary
Baseline
Probability
August 2015, %
22
Probability
Novem ber 2015, %
28
Change, %
6
10
12
2
7
0
-7
0
2
2
57
55
-2
Source: Schroder Economics Group, 20 November 2015. Previous forecast from August
2015. Please note the forecast warning at the back of the document.
The increase in risk of a deflationary outcome relative to the baseline is a
concern given the low level of interest rates and perception that QE cannot
deliver a durable boost to growth. Should we have a deflationary shock there will
be doubts about the ability of the central banks to dig us out of the hole. This is
why we have described the world economy as a “wobbly bike”: slow moving and
vulnerable to shocks. From a market perspective this represents a concern as
the ability of central banks to underwrite asset values becomes increasingly
questioned.
7
December 2015
For professional investors only
European forecast update: downgrades for 2016
Communication from European Central Bank (ECB) President Mario Draghi has
notably shifted from being relaxed about the state of Europe’s recovery to being
concerned enough to consider adding further monetary stimulus. Growth has been
softer of late, but could have been far worse given the weakness in emerging markets.
Meanwhile, the government in the UK has just confirmed substantial austerity to be
implemented over the course of the next four years. Yet, the independent Office for
Budgetary Responsibility (OBR) expects the economy to continue to grow at a similar
pace to this year. It seems that the likelihood of a borrowing overshoot is high, which
could force monetary policy to remain looser for longer.
Eurozone growth losing momentum
Growth in the
Eurozone fell
back in Q3…
Eurozone GDP growth slowed to 0.3% quarter-on-quarter in the third quarter
compared to 0.4% in the second quarter and 0.5% in the first. The slowdown in
growth comes as a slight disappointment for markets where consensus
expectations were for 0.4% growth. The majority of member states saw a small
drop in their quarterly growth rates, with the exceptions of Greece and France, with
the former seeing a larger drop caused by bailout shenanigans earlier this year,
while France saw a slight acceleration (see chart 6).
Chart 6: Eurozone growth softens in Q3
%, q/q
1.2
1.0
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
Gre
Por
Aus
Neth
Q2
Ita
Bel
Fra
EZ19
Ger
UK
Spa
Q3
Source: Eurostat, Schroders Economics Group, 26 November 2015.
…as most
member states
saw a slight
slowdown in
activity
Within the member states, Germany disappointed with growth also slowing from
0.4% to 0.3% quarter-on-quarter. The expenditure breakdown shows continued
growth in household and government consumption, but a slowdown in investment.
Net trade made a negative contribution, but mainly due to a rise in imports, rather
than a fall in exports. Imports are rising in line with the pick up in household
consumption and total investment, which should help other countries benefit from
Germany’s large external surplus.
The slowdown in investment may be related to uncertainty caused by concerns
over the state of the Chinese economy. Exports from Germany to China have
certainly been affected, falling 8.4% in the third quarter compared to the same
period a year earlier. However, exports to the US and UK have been much more
healthy, at 16.6% and 12.5% respectively, easily offsetting weakness from China.
Growth in France picked up from a flat second quarter to 0.3% growth quarter-onquarter in the third. However, details within the data show that final demand was
much weaker than implied by the headline GDP figure. When inventories are
excluded, France’s GDP would have contracted by 0.5%.
8
December 2015
For professional investors only
Elsewhere, Italy continues to struggle, recording just 0.2% growth and appears to
have lost the momentum it had built up at the start of the year. Otherwise, Spain
posted strong growth of 0.8%, which is a slight moderation compared to 1%
quarter-on-quarter growth in the previous quarter. Negative inflation has continued
to boost the spending power of Spanish households. Household consumption rose
by 4% annualised in the third quarter – the fastest pace of growth since the fourth
quarter of 2007. Investment growth eased following very strong growth in the
previous quarter, and while exports have also been growing strongly, imports
accelerated sharply, reflecting stronger domestic demand, but also acting as a
slight drag on GDP growth.
Eurozone forecast: small downgrades
Despite growth figures being weaker than consensus estimates, our forecast was
for an even weaker outcome. As a result of this and in combination with upward
revisions to historical data, our Eurozone GDP forecast has been revised up from
1.3% to 1.5% for 2015. However, the loss in momentum over the last 3 – 6 months,
partly as a result of a weaker external environment, but also as some of the
domestic tailwinds start to recede, suggest growth will struggle to accelerate much
further from here. Therefore, we forecast the pace of growth to be maintained at
1.5% for 2016, as opposed to the acceleration we had expected previously. We
then see a slight pick-up in growth heading into 2017 as the external environment
improves, specifically in the emerging markets.
Table 3: Eurozone GDP forecast
Our Eurozone
GDP has been
downgraded for
2016…
2015
Prev.
2016
Prev.
2017
Germany
1.5
1.3
1.7
2.1
2.1
France
1.1
1.1
0.9
1.1
1.2
Italy
0.7
0.6
0.9
1.1
0.7
Spain
3.1
3.2
2.9
2.9
2.5
Eurozone
1.5
1.3
1.5
1.7
1.6
Source: Schroders Economics Group, 20 November 2015. Previous forecast from August 2015.
Please note the forecast warning at the back of the document.
The weakness in emerging markets is likely to hit Germany the hardest of the big
four member states. For this reason, our forecast for German growth in 2016 saw
the biggest downgrade. The 2016 forecasts for France and Italy have also been
revised down, but not to the same extent. Only Spain’s forecast is left unchanged
thanks to continued positive surprises, especially the recent improvements within
the labour market (lower unemployment and higher pay growth).
…however, the
forecast for
inflation has
been revised up
The Eurozone inflation forecast has been updated to take into account the recent
upside surprise in core inflation (which excludes food and energy), but also the fall
in global oil and gas prices (chart 7 on next page). The end result is a slight upward
revision to this year’s forecast and the 2016 forecast (from 1.1% to 1.3%).
Extending out into 2017, we continue to see subdued domestically-generated
inflation, but with the drag from food and energy dropping out of the annual
comparison (we forecast inflation to rise to 1.6%).
The outlook for monetary policy has been muddied by the ECB’s reaction to recent
concerns over China, volatility in financial markets, and the Fed’s decision not to
hike interest rates in September. These factors helped push the euro higher
against the US dollar, undoing the depreciation since the start of quantitative
easing (QE). ECB President Mario Draghi has strongly hinted that additional
monetary easing could follow as soon as December, but he was careful to caveat
that this would be dependent on the new forecast from ECB staff.
9
December 2015
For professional investors only
Chart 7: Eurozone GDP forecast Chart 8: Eurozone inflation forecast
y/y
2.0%
y/y
2.0%
1.5%
1.5%
1.0%
1.0%
0.5%
HICP inflation
forecast
0.5%
Real GDP
forecast
i ii iii iv i ii iii iv i ii iii iv i ii iii iv
2014
2015
2016
2017
0.0%
-0.5%
i ii iii iv i ii iii iv i ii iii iv i ii iii iv
2014
2015
2016
2017
Current forecast
Previous forecast
Current forecast
Previous forecast
Source: Thomson Datastream, Schroders Economics Group, 20 November 2015. Previous
forecast from August 2015. Please note the forecast warning at the back of the document.
There is a high
chance of further
monetary easing
from the ECB…
We think there is a high chance that additional stimulus is added in December.
This could come in the form of expanding asset purchases beyond the €60 billion
per month, or it could come through an extension to QE beyond September
2016. It could also come through a further cut in interest rates, taking the deposit
rate further into negative territory. Draghi had in the past stated that interest rates
were at the lower bound, but more recent comments suggest that they could fall
further, especially as banks have not passed on the cost of holding deposits on
to household customers. Corporates on the other hand have started to be
charged for their deposits.
However, we also think there is a high probability that the ECB decides not to
add stimulus in December, but instead decides to extend asset purchases at a
later point (the forecast assumes an extension until the end of 2016 – adding an
extra €180 billion). This would be consistent with the recent pick up in leading
indicators such as the purchasing managers indices, along with the higher than
expected recorded inflation for October. Moreover, stronger data in recent weeks
in the US has increased the probability of the Fed hiking its main policy rate at its
meeting in mid-December. This has helped the euro depreciate once again close
to some of the lows we have seen this year. Taken together, it appears that
many of the factors that had warranted concerns have now eased if not reversed.
There is still a concern over the outlook for China, but with Eurozone trade
remaining robust in total due to strength in other markets, this should be less of a
concern.
…although, we
do not expect it
to have much of
an impact.
10
If the ECB does, however, decide to add further stimulus, then we would expect it
to have some additional impact on the currency, but we doubt that it will help with
regards to the real economy or the financial sector. The Eurozone is awash with
liquidity, both in financial markets and in the real economy. For example, growth
in the real narrow supply of money (M1) is up 14% – close to the highs seen in in
2009 and in 2005. Real M1 growth is a measure of physical currency in
circulation, plus overnight deposits, which are then deflated using the
harmonised index of consumer prices (HICP) inflation. As illustrated in chart 9, it
has historically provided a useful nine-month lead on real GDP growth. It
currently suggests that growth could accelerate to between 3-5% year-on-year –
an upside risk to our more cautious forecast.
December 2015
For professional investors only
Chart 9: Boost from monetary stimulus provides upside risks
y/y
y/y
20%
8%
6%
15%
4%
10%
2%
5%
0%
-2%
0%
-4%
-5%
-6%
-10%
-8%
03
04
05
06
07
08
09
10
Real M1 (CPI) growth, lhs (9m lead)
11
12
13
14
15
Real GDP growth, rhs
Source: Thomson Datastream, Schroders Economics Group, 26 November 2015.
Finally on the Eurozone, we have pencilled in the first interest rate rise at the end
of 2017. This would be consistent with inflation returning close to but below 2%,
with growth continuing to run above trend. Clearly the risk to this forecast is for
no hike, and possibly even further cuts during our forecast horizon.
UK forecast: Downside growth surprises to delay rate hikes
The UK growth
forecast has
been
downgraded…
The UK’s macro themes are largely unchanged, however, they appear to be
playing out a little sooner than we had expected. Our forecast assumes a
slowdown heading into 2016 and 2017 caused by the resumption of austerity
efforts, a pick up in inflation caused by diminishing spare capacity, and an
appreciation of sterling against the euro – the UK’s most important trading
partner. None of these themes have changed, but downward revisions to 2014
growth data, along with more recent downside GDP surprises have led us to
conclude that the economy is further ahead on our expected path that we had
forecast in August (chart 10).
Chart 10: UK GDP forecast
…as the
expected
slowdown
appears to be
playing out
sooner than
previously
forecast
Chart 11: UK inflation forecast
y/y
4.0%
y/y
2.5%
3.5%
Real GDP
forecast
3.0%
2.0%
1.5%
CPI
inflation
forecast
2.5%
1.0%
2.0%
0.5%
1.5%
0.0%
1.0%
0.5%
-0.5%
i ii iii iv i ii iii iv i ii iii iv i ii iii iv
2014
2015
Current forecast
2016
2017
Previous forecast
i ii iii iv i ii iii iv i ii iii iv i ii iii iv
2014
2015
Current forecast
2016
2017
Previous forecast
Source: Thomson Datastream, Schroders Economics Group, 20 November 2015. Previous
forecast from August 2015. Please note the forecast warning at the back of the document.
11
December 2015
For professional investors only
Real quarterly GDP growth fell from 0.7% in the second quarter to 0.5% in the
third quarter. The breakdown of expenditure shows robust domestic demand –
consumption up 0.8% quarter-on-quarter, both government consumption and
investment accelerating to 1.3% quarter-on-quarter – going against recent trends
across Europe. Total domestic demand alone contributed two percentage points
to GDP, however, strong demand was met with a lack of supply, forcing imports
sharply higher, and thus detracting from overall GDP. Imports grew by 5.5% on
the quarter against 0.9% growth in exports, causing a negative contribution of 1.5
percentage points to GDP.
In terms of our forecast, we have downgraded growth for 2015 from 2.5% to
2.3%, and also revised down 2016 growth from 2.1% to 1.9%. Looking further
ahead at 2017, we expect the economy to slow to 1.6%, but this should be the
trough for GDP growth over the medium-term. The negative impact from fiscal
tightening should then begin to ease, although our forecast is based on the
projected path of austerity by the government and OBR. The latest update from
the Chancellor showed a slight delay in austerity, which could easily happen
again given what we think are optimistic growth and tax revenue forecasts. For
more on the UK 2015 Autumn Statement, see ‘Schroders Quickview: UK
Chancellor remains defiant in implementing austerity’.
The UK inflation
forecast has also
been
downgraded…
The forecast for UK inflation in 2016 has also been revised down despite inflation
running a littler higher than we had forecast in the last quarter. CPI inflation
should average 1.3% over 2016, revised down from 1.6% due to a lower profile
from international wholesale energy costs, but also greater disinflationary
pressure from emerging markets. Due to the UK’s reliance on imports, it has a
reasonably high pass-through of import price shocks to domestic inflation. The
build-up of overcapacity in global manufacturing, but in particular of finished
consumer goods from emerging markets, should keep UK inflation low.
The risks to our UK growth and inflation forecasts are skewed towards a more
deflationary outcome. The risk scenarios discussed earlier and detailed on page
20 suggest that a number of external risks could keep corporates and investors
cautious. We have not included 'Brexit' risks in our scenarios as this would not
have a substantial impact on global growth and inflation, however, the
uncertainty that the EU referendum raises for investors is bound to negatively
impact UK growth.
With regards to monetary policy, we have previously linked the first Bank of
England (BoE) rate rise to headline CPI inflation rising above 1% – the BoE’s
lower threshold of its central 2% target. Based on the latest inflation forecast, this
would suggest a delay in the first hike from May (our previous forecast) to
August. We then expect the Bank to hike at a pace of 25 basis points per quarter
as before.
However, our growth forecast for 2017 presents a challenge in that should
growth slow to sub-2%, the Bank may consider this to be adding to spare
capacity, and therefore deflationary pressures. As a result, we only forecast the
Bank to raise interest rates to 1.25% by February 2017, at which point it will
recognise the slowdown and be forced to pause. The Bank may then decide to
restart hikes in 2018 or 2019, but that would be contingent on growth reaccelerating. Forecasting that far out is always hazardous, but we are puzzled by
the OBR and BoE’s forecasts, neither of which factor in any slowdown from fiscal
tightening or interest rate rises. The experience of fiscal tightening in 2011 and
the subsequent slump in growth in 2012 will surely be repeated to some extent in
2016 and 2017.
12
December 2015
… which should
delay and limit
BoE rate rises…
For professional investors only
Our cautious forecast on BoE interest rates is still higher than what is priced into
money markets. Based on futures on overnight interest rate swaps, investors are
not fully pricing in a rate rise of 25 basis points until March 2017, with only one
more rate rise priced in for the rest of that year (chart 12). It may be that markets
on average have an even more negative view on the UK economy than we do, or
it could be that money markets are being influenced by the huge liquidity being
injected by the ECB and Bank of Japan. In any case, there is little pressure from
markets for interest rates to rise.
Chart 12: UK Policy interest rate forecast vs. market expectations
%
1.75
1.50
1.25
1.00
0.75
0.50
0.25
0.00
Jan 15
Jul 15
Current forecast
Jan 16
Jul 16
Previous forecast
Jan 17
Jul 17
GBP OIS (SONIA) curve
Source: Thomson Datastream, Schroders Economics Group, 26 November 2015. Previous
forecast from August 2015. Please note the forecast warning at the back of the document.
…and may also
put sterling under
pressure
In terms of the risks to our UK interest rate forecast, they have shifted from rates
rising sooner than forecast to even later. Governor Mark Carney has recently
shed his hawkish feathers for more dovish colours. Not the first time of course.
From 2017 onwards, we believe there is a greater risk that the Bank of England
is forced to cut rates again rather than raise them further. The softer outlook for
interest rates along with the uncertainty and concerns that will emerge in 2016 as
the UK’s referendum on its membership of the European Union approaches
could put sterling pressure.
13
December 2015
For professional investors only
EM forecast update: an uneven recovery
Downward
revisions to the
BRIC forecasts
(again)
Another quarter, another downgrade for emerging market growth. But there is
some good news on the horizon. Extending our forecast period out to 2017, we
begin to see growth improving outside of China, with India continuing its gradual
gains, while Brazil and Russia should begin to stage recoveries after a testing
period. China’s deceleration seems inevitable, given demographic and structural
factors. On inflation, although the commodity windfall is mostly realised,
idiosyncratic problems unwinding in Russia and Brazil should see improvements
in the outlook.
Table 4: Summary of BRIC forecasts
% per
annum
China
GDP
Inflation
2014
7.3
2015f
6.9 
2016f
6.3 
2017f
6.2
2014
2.0
2015f
1.6
2016f
1.9 
2017f
2.1
Brazil
0.2
-2.9 
-2.1 
1.2
India
6.9
7.2 
7.5 
7.9
6.3
8.9
6.5 
5.2
7.2
5.0 
5.7 
5.3
Russia
0.6
-3.8 
-0.2 
1.5
7.8
15.3 
7.1 
6.7
BRICs
5.5
4.4 
4.6 
4.8
3.8
4.6 
3.6 
3.4
Source: Bloomberg, Thomson Datastream, Schroders Economics Group, 19 November 2015.
Previous forecast from August 2015. Please note the forecast warning at the back of the
document.
China: stimulus will not stop the slowdown
Multi-year
deceleration still
expected for
China
Though we still await the official growth target for 2016 (to be announced in
March), it has been heavily hinted that 6.5% is the new goal. This growth rate
would mean China reaches the objective set in 2010 of doubling GDP and
incomes by 2020. Unfortunately, we do not believe China is capable of safely
growing at 6.5% a year for the rest of this decade. The slowdown we have
witnessed in economic growth is driven by a host of structural factors, rather than
being cyclical in nature. With none of these problems resolved, there is no
reason the deceleration should plateau at 6.5% for the next four years. Indeed,
we expect a marked deceleration in 2016 compared to this year and a continued,
slower decline thereafter. 2015 growth has been propped up by an outsized
contribution from the financial sector which will not repeat next year, creating
unfavourable base effects. Beyond that, there is plenty to worry about.
Chart 13: Equity cash flowed into property when the market turned
y/y, %
y/y, %
12
140
10
120
8
100
6
80
4
60
2
40
0
20
-2
-4
0
-6
-20
-8
-40
Jan 14
Apr 14
Jul 14
Oct 14
House prices (rhs)
Jan 15
Apr 15
Jul 15
SHCOMP
Source: Thomson Datastream, Schroders Economics Group, 25 November 2015
14
Oct 15
December 2015
Structural issues
are still far from
resolved
For professional investors only
Our own visit to China last month gave ample demonstration that overcapacity is
yet to be meaningfully tackled, that the property market correction is far from
over, and economic sentiment generally downbeat. Consequently, although the
latest data from China has pointed to a stabilisation and even a small recovery in
some areas of activity, it is difficult to see this persisting throughout 2016. Rather,
we think the October improvement is based largely on stimulus and will be short
lived, while the property market is once again beginning to wobble. The recovery
here appears to have been driven by the slumping equity market in the summer,
with funds withdrawn and invested instead in real estate. This was suggested by
the inverse relationship between the two markets at the time (chart 13) and
supported by wealth managers in China. The recent equity revival then has
potentially worrying implications for property.
Stimulus can, of course, be ramped up further, and we expect an additional
200bps of reserve requirement ratio (RRR) cuts next year, alongside around
85bps of interest rate cuts and expansionary fiscal policy. But given how much
stimulus we have seen this year, it is unlikely this will be enough to deliver
acceleration in growth. In addition, policy effectiveness appears to be
diminishing. Fiscal stimulus so far has been undermined by local government
unwillingness to participate in big infrastructure projects for fear of being accused
of corruption, an unwanted side effect of the extensive anti-corruption campaign.
Meanwhile, monetary policy has struggled to reduce the effective lending rate at
a time of deflation (chart 14) and in any case, there is falling demand for credit.
The one positive from all this excess capacity is that the attendant deflationary
pressures should keep Consumer Price Index (CPI) inflation contained well
below the 3% target, providing ample room for monetary easing.
Chart 14: Effective lending rate in China has risen for corporates
Effective lending rate (%)
12
10
8
6
4
2
0
Nov 12
May 13
Nov 13
May 14
Nov 14
Corporate
Household
May 15
Nov 15
Source: Thomson Datastream, Schroders Economics Group, 25 November 2015.
Gradual RMB
devaluation more
likely than a large
jump
15
Finally, the possibility of currency devaluation continues to be a matter of much
debate. The renminbi remains overvalued by some 15 – 20% on a real effective
exchange rate basis, and a move to a free float would undoubtedly see a large
depreciation. However, the authorities for now appear wedded to a cautious
approach, with an eye on the likely political and financial stability consequences
of such a move. Our base case scenario remains a gradual weakening of the
currency over the next two years, though we would attach a growing weight to a
larger one-off devaluation as growth slows and domestic exposures to the
yuan/US dollar exchange rate are reduced.
December 2015
For professional investors only
Brazil: more pain, little gain
Political paralysis
prevents
progress
The political situation has continued to deteriorate in Brazil, such that
policymaker focus now is almost entirely on the fallout from the Petrobras
corruption scandal. Hopes that the rapidly worsening economic situation would
force politicians to act have been scotched, as opposition parties seem happy to
stoke the fires of discontent against the government and push for President
Rousseff’s impeachment. Without reform efforts or indeed anything resembling
coherent policy, we are forced to downgrade; 2016 is set to be another very
disappointing year for growth. However, a recovery should be underway in 2017.
As we wrote last month, short-term prospects seem bleak. The current trend both
in politics and economic activity is a negative one, as reflected by the recent S&P
and Fitch downgrades. These have taken the country’s sovereign debt to within a
whisker of junk status, driven by concern over the fiscal consolidation process.
We have written many times, too, on the supply side issues plaguing the
economy that have contributed to the persistent inflation problem, and the ‘Dutch
disease’ inflicted by the multi-year commodity boom, which drove up unit labour
costs and rendered Brazilian industry uncompetitive.
No scope for
reform until the
scandal settles
On the fiscal and supply side concerns, there is little hope for immediate relief. The
political situation all but guarantees a lack of productive legislation until a new
government comes to power, unencumbered by corruption allegations and
infighting. This, in turn, means investment and consumption decisions are likely to
be deferred. However, market forces are beginning – if only by a war of attrition –
to generate an improvement in other metrics. For example, unit labour costs have
finally begun to decline as unemployment builds, which ought to lead to an
improvement on the trade balance, as seems to be happening. Unfortunately, if
Brazil is to rely on this kind of adjustment, rather than market reforms, we will need
to see much more destruction of domestic demand before the process is complete.
Chart 15: From bad to worse; inflation keeps climbing
%, y/y
10
%
15
14
9
13
8
12
7
11
10
6
9
5
4
2010
8
7
2011
2012
CPI
2013
2014
2015
Selic target rate (rhs)
Source: Thomson Datastream, Schroders Economics Group, 25 November 2015.
Inflation remains stubbornly high despite aggressive monetary tightening,
reaching multi-year highs (chart 15). Part of this stems from Brazil’s tight supply
side, but it also has much to do with currency weakness and increases in
regulated prices. Petrobras has begun hiking its prices as it seeks a more
sustainable footing – an important and necessary change, but unfortunately one
that comes at an inopportune time for Brazil. Consequently, we now see little
chance of a rate cut next year, and instead expect rates to remain on hold
throughout 2016.
16
December 2015
For professional investors only
India: a dimming hope
Reform
disappointments
continue…
It is tempting here to simply write “Please refer to our August forecast update”,
because so little has fundamentally changed. We again apply a small downgrade
to the outlook but still expect India to grow faster than any other emerging market
economy – though we remain sceptical on the official GDP numbers. We have
still had no substantive reform progress and there seems little prospect of it until
Prime Minister Modi learns to reach out and build consensus.
Not only have the Bharatiya Janata Party (BJP) failed to push through the
marquee reforms like the goods and services tax or measures on land
acquisition, they have recently suffered an additional setback in the form of a
heavy election defeat in the state of Bihar. Victory here would have provided
useful additional seats in India’s Upper House, making headway towards
majorities in both legislatures for the BJP. That date is now further away, if
indeed it will ever arrive.
…but
improvements
still happening at
the margin
However, one encouraging development following this defeat was the BJP’s
reaction. There were concerns that the party might view the defeat as repudiation
of reforms by the electorate, and drive a more populist policy line, with the BJP
eschewing difficult but much needed structural changes. Happily though, the first
noticeable policy announcement since the election disappointment was one for
gas price liberalisation, which does not require parliamentary approval and will
greatly improve the incentives for natural gas investment. Though the immediate
economic impact will be limited, it strengthens the medium-term outlook but,
more importantly, reassures that the government remains committed to
liberalising and reforming India’s economy.
For now, growth looks set for a modest acceleration, likely driven by consumption
rather than investment, where sentiment is lukewarm as corporates await
concrete legislative advances. Private sector banks are reportedly happy to
provide consumer credit and see little demand for corporate lending, so we
expect this to be a key growth driver in India in 2016.
Chart 16: Indian growth increasingly reliant on consumption
%, y/y
20
15
10
5
0
-5
-10
-15
-20
-25
-30
Apr 12
Oct 12
IP, y/y 3mma
Apr 13
Oct 13
Apr 14
Exports, y/y, 3mma
Oct 14
Apr 15
Oct 15
Car sales, y/y, 3mma
Source: Thomson Datastream, Schroders Economic Group. 25 November 2015.
Monetary policy remains robust, with Governor Rajan at the helm until Q3 2016.
The central bank delivered 50bps of cuts in the third quarter of this year,
essentially frontloading rate cuts. Governor Rajan has signalled that he believes
this should be sufficient easing given it takes the cutting cycle up to 125bps so
far. The problem is that banks appear to have only passed on around 75bps of
cuts in their lending rates – further monetary easing may need to involve
macroprudential or competition-enhancing measures to reduce lending frictions.
17
December 2015
For professional investors only
The ultimate inflation target of 4%, and the end of the benefits from the
commodity price fall, will constrain further easing, particularly as inflation
pressures appear to be edging up.
Russia: rumble resolved?
It finally looks as though the worst may be behind Russia, with Q3 GDP data
beating both expectations and the previous quarter, contracting 4.1% compared
to 4.6% previously. Obviously, this is still an extremely poor economic
performance, but it does mark a likely inflection point, particularly in combination
with data from the industrial side of the economy, where production has been
recovering gradually. The consumption side continues to deteriorate, as might be
expected given rising unemployment and falling wages, but by compressing
import demand this may actually help the net export contribution and the current
account.
Russia close to
bottoming out,
worst of oil
shock over
Meanwhile, the fall in the oil price has taken most of its toll, and barring further
large falls we should not see an additional drag on growth in 2016 and 2017.
Furthermore, government spending is set to remain somewhat supportive given
the planned 3% budget deficit. As a result, we forecast a gradual recovery over
the next two years, with growth essentially flat next year and growing 1.5% in
2017 once balance sheets are repaired and investment begins to grow from a
lower base.
All the same, we do not see a strong rebound in Russian activity, as the
economy remains heavily dependent on oil, and our expectation here is that
prices remain around current levels for the next two years. Certainly, we do not
see a return to triple digit prices. Absent any economic reforms, it is difficult to get
excited about Russian growth.
Chart 17: Adjustment to lower oil almost done
%, y/y
%, y/y
20
20
10
15
0
10
-10
5
-20
-30
0
-40
-5
-10
Jan 12
-50
-60
Jul 12
CPI
Jan 13
IP
Jul 13
Jan 14
Retail sales
Jul 14
Jan 15
Jul 15
Brent oil price (rhs)
Source: Thomson Datastream, Schroders Economic Group. 25 November 2015.
Inflation has run rampant in Russia this year, as the collapse of oil took the
rouble with it, while import sanctions also did not help. Monetary policy has
stayed tight in response. However, as the oil effects drop out heading into 2016,
inflation should drop markedly, though structural supply side problems will ensure
it remains high relative to the emerging market average. All the same, this should
provide space for monetary policy easing.
18
December 2015
For professional investors only
Schroder Economics Group: Views at a glance
Macro summary – December 2015
Key points
Baseline

2016 global growth is now forecast at 2.6%, with expectations revised down across all markets. As 2015
growth is projected to reach 2.5%, this marks a slight acceleration, but essentially reflects the lack of
momentum we are seeing in global demand and the problem of excess inventories. 2017 offers a slight
acceleration to 2.8% as EM and Europe improves, but ultimately, the square-root recovery continues.

The US Fed is expected to look through the low headline CPI inflation rate and focus on a firmer core
inflation and tightening labour market, hiking in December 2015. We had expected a March 2016 lift-off,
but having shifted the goalposts by dropping concerns about China at the last meeting, we now see little
reason for the FOMC to delay. We expect the Fed funds rate to rise to 1.25% by end 2016 and 2% by end
2017, where it peaks.

UK recovery to continue, but to moderate in 2016 with the resumption of austerity. Interest rate
normalisation to begin with first rate rise in August 2016 after the trough in CPI inflation. BoE to move
cautiously, hiking 25 bps per quarter, peaking at around 1.25% in February 2017 when weaker activity will
force a pause.

Eurozone recovery continues in 2016 but does not accelerate as tailwinds fade and the external
environment drags on growth, before picking up in 2017. Inflation to turn positive again in 2016 and rise
modestly into 2017. ECB to keep rates on hold and continue sovereign QE through to September 2016.

Despite the weak yen, low oil prices and the absence of fiscal tightening in 2015, Japanese growth has
disappointed. A limited pick-up is expected in 2016 as wages rise, but Abenomics faces a considerable
challenge over the medium-term to balance recovery with fiscal consolidation. The external environment
does not help either. Despite this, we do not expect the Bank of Japan to increase QQE.

Emerging economies benefit from modest advanced economy growth, but tighter US monetary policy
weighs on activity, while commodity weakness will continue to hinder big producers. Concerns over
China’s growth to persist, further fiscal support and easing from the PBoC is likely.
Risks

Risks skewed towards deflation on fears of China hard landing, currency wars and a US recession. The
risk that Fed rate hikes lead to widespread EM defaults would also push the world economy in a
deflationary direction. Inflationary risks stem from a significant wage acceleration in the US, or a global
push toward reflation by policymakers. Finally, conflict in the Middle East could hit oil supply, leading to a
jump in inflation and a hit to growth.
Chart: World GDP forecast
Contributions to World GDP growth (y/y), %
6
4.9 4.5 5.0 5.1
4.9
5
3.6
4
2.9
2.5
3
4.6
Forecast
3.3
2.5 2.6 2.6 2.5
2.2
2.9
2
1
0
-1
-1.3
-2
-3
00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
US
Europe
Japan
Rest of advanced
BRICS
Rest of emerging
World
Source: Thomson Datastream, Schroders Economics Group, August 2015 forecast. Please note the forecast warning at
the back of the document.
19
December 2015
For professional investors only
Schroders Forecast Scenarios
Global vs. 2016 baseline
Scenario
Summary
Macro impact
Baseline
We have trimmed our forecast for global growth to 2.6% for 2016 (previously 2.9%) as a result of
modest downgrades to the Advanced and Emerging markets. Although global demand has held
up in 2015H2, there is little momentum and still some signs of excess inventory to clear. The
benefits from lower oil prices will continue to support consumer spending but inflation is set to
rise and the oil dividend fade in 2016. For the emerging economies, China continues to decelerate
in 2016, but signs of stability in Russia and Brazil result in a better year for the BRIC's. The global
growth forecast for 2017 is 2.8%, with growth moderating in the advanced economies in response
to monetary tightening in the US whilst EM growth is marginally higher.
Inflation is expected to pick-up in 2016 as the base effects from lower commodity prices drop out of the index.
Global inflation rises to 3.7% in 2016 from an estimated 3.1% in 2015 led by the advanced economies which
see a pick-up of around 1 percentage point. For the EM, inflation moderates as CPI indices are less commodity
sensitive (due to greater regulation of fuel prices) and currencies stabilise. The US Fed is expected to look
through the current low headline CPI rate and focus on a firmer core rate of inflation and tightening labour market
so as to raise rates in December 2015. We expect the Fed funds rate to rise to 0.5% by end 2015, 1.25% by
end 2016 and 2% by end 2017 where it peaks. We look for the ECB to extend QE beyond September 2016 and
leave policy rates unchanged until the end of 2017 when we expect the first hike. For the UK, we expect the first
rate hike in August 2016. In Japan, the BoJ will keep the threat of more QQE on the table, but is now likely to
let the weaker JPY support the economy and refrain from further loosening. China is expected to cut interest
rates and the RRR further.
After a period of truce, the currency wars return as China devalues the CNY by 20% in January
2016. The Chinese authorities choose to go for a large one-off move rather than a series of
smaller moves so as to quash speculation about further devaluation. Japan, which counts China
as its largest trading partner, responds by devaluing the JPY three months later by 8%. This is
likely to be achieved through an increase in QQE. Finally, the ECB responds by stepping up its
own QE programme and pushing the EUR down by 10%. The round of currency devaluations
unnerves financial markets who see it as a symptom of a chronically weak world economy.
Weaker equity markets then have a further knock on effect to activity through slower consumption
through negative wealth effects and weaker investment as growth expectations decline.
Mild deflation: The impact on the world economy is modestly deflationary with mixed results between EM and
DM. Inflation is pushed up in China and the EM, whilst the advanced economies experience weaker growth and
lower inflation. Overall the global effects are not great as much of the moves in exchange rates cancel each
other out. However, the USD does strengthen as a result of each of devaluation thus putting deflationary
pressure on the US. There is also a general deflationary effect on activity from heightened financial market
volatility.
Probability* Growth Inflation
55%
-
-
6%
-0.2%
-0.1%
Reflationary: stronger growth and higher inflation compared to the baseline. Central banks respond to the
increase in inflationary pressure with the fastest response coming from the US and UK which are more
advanced in the cycle compared with the Eurozone where there is considerable slack. The US Fed raises rates
to 3.5% by end-2016 and starts to actively unwind QE by reducing its balance sheet. Although there is little
slack in Japan, higher wage and price inflation is welcomed as the economy approaches its 2% inflation target.
This is likely to lead the BoJ to signal a tapering of QQE, but no increase in interest rates. Inflation concerns
result in tighter monetary policy in the emerging markets with all the BRIC economies raising rates.
5%
+0.7% +0.5%
Tensions in Syria spill over in the Middle East with the result that oil supplies are disrupted in
Iraq. With demand continuing to recover, this results in a surge in the oil price toward $90/ barrel
by end 2017.
Stagflationary: although cuts in energy capex are cancelled and the outlook for the sector brightens, higher
inflation weakens consumer spending and growth worldwide. The EM economies fare slightly better due to the
greater number of producers, but growth losses in China and India weigh on the group as a whole. On the policy
front, higher inflation results in a slightly faster tightening of policy by the Fed although rates are still expected
to peak at 2% as the central bank balances the increase in inflation against the slowdown in growth.
2%
-0.3% +0.7%
Slower profits growth causes a retrenchment in the corporate sector which cuts capex and jobs.
Consequently, the US economy tips into recession in the first half of 2016. Corporate confidence
and the equity market are badly hit, resulting in widespread retrenchment. Weaker demand from
the US hits global activity.
Deflationary: weaker global growth and inflation compared to baseline as the fall in US demand hits activity
around the world. The fall in inflation is given added impetus by a drop in commodity prices, which then adds to
pressure on energy and mining companies and producers. The Fed makes one rate hike in December this year,
but has to reverse course in March 2016 when rates are cut back again and the QE programme restarted.
Interest rates are generally lower around the world.
4%
-0.9%
-0.4%
The equity market collapses despite government support efforts, inflicting losses and a crisis of
confidence across the financial sector. With government credibility crushed, bank guarantees are
called into question and bank runs begin. Lending activity halts and the housing market slumps,
impacting consumption and investment. Growth in China slows to 3.5% in 2016 and remains
under 4% in 2017.
Deflationary: Global growth slows as China demand weakens with commodity producers hit hardest. However,
the fall in commodity prices will push down inflation to the benefit of consumers. Monetary policy is likely to
ease/ stay on hold while the deflationary shock works through the world economy.
8%
-0.8%
-0.5%
6. US wages
accelerate
Tight labour markets and rising headline inflation cause wages to accelerate faster than in the
base in the US, parts of Europe and Japan. Consumer spending initially accelerates compared to
the base, but inflation also picks up further out.
Reflationary in 2016: stronger growth and higher inflation compared to the baseline. Note that this scenario will
turn stagflationary in 2017 as growth slows whilst inflation remains elevated. Better growth in the US provides a
modest stimulus to activity elsewhere, however this is likely to be tempered by a more volatile financial
environment with long yields rising as inflation expectations rise and the Fed tightens more aggressively.
7%
+0.3% +0.4%
7. EM defaults
emerge
With little prospect of a recovery in commodity prices the banks take a more restrictive approach
to energy and metal producers with the result that we see a series of defaults in 2016 as hedges
roll off and cash flows deteriorate. Problems are concentrated amongst the commodity producers
with weaker balance sheets such as Brazil, although there is a knock-on effect to the region. The
deterioration in EM credit conditions is exacerbated by Fed tightening which reduces capital
flows/ prompts capital flight from EM.
Deflationary: weaker growth and inflation vs. baseline. Global trade takes another hit as commodity producers
are forced to retrench with knock on effects across the EM complex. Advanced economies experience weaker
demand from EM, stronger currencies and more volatile financial markets as bank defaults increase risk
aversion. Fed continues to tighten but more slowly with rates peaking at a lower level than in the baseline.
10%
-0.5%
-0.3%
3%
-
-
1. Currency wars
return
2. Global reflation Frustration with the weakness of global activity leads policy makers to increase fiscal stimulus in
the world economy. This then triggers an increase in animal spirits which further boosts demand
through stronger capex. Global growth exceeds 3% in 2016 and 2017. However, higher
commodity prices (oil heading toward $70/ b) and tighter labour markets push inflation up by
0.5% in 2016.
3. Middle-East
melee hits oil
4. US recession
5. China hard
landing
8. Other
*Scenario probabilities are based on mutually exclusive scenarios. Please note the forecast warning at the back of the document.
*Scenario
probabilities are based on mutually exclusive scenarios. Please note the forecast warning at the back of the document
20
December 2015
For professional investors only
Schroders Baseline Forecast
Real GDP
y/y%
World
Advanced*
US
Eurozone
Germany
UK
Japan
Total Emerging**
BRICs
China
Wt (%)
100
62.4
24.7
19.0
5.5
4.2
6.5
37.6
23.6
14.7
2014
2.7
1.7
2.4
0.9
1.6
2.9
-0.1
4.4
5.5
7.3
2015
2.5
1.9
2.4
1.5
1.5
2.3
0.6
3.5
4.4
6.9
Wt (%)
100
62.4
24.7
19.0
5.5
4.2
6.5
37.6
23.6
14.7
2014
2.7
1.3
1.6
0.4
0.8
1.5
2.7
5.0
3.8
2.0
2015
3.1
0.4
0.3
0.1
0.2
0.1
0.9
7.6
4.6
1.6
Current
0.25
0.50
0.05
0.10
4.35
2014
0.25
0.50
0.05
0.10
5.60
2015
Prev.
0.50  (0.25)
0.50
(0.50)
0.05
(0.05)
0.10
(0.10)
4.35  (4.60)
Current
4484
133
371
365.4
18.00
2014
4498
31
375
300
20.00
2015
Prev.
4489  (4504)
649
(649)
375
(375)
387  (389)
17.00  17.50
Current
1.52
1.07
122.8
0.71
6.37
2014
1.56
1.21
119.9
0.78
6.20
2015
1.53
1.08
120.0
0.71
6.40 
43.4
56










Prev.
(2.4)
(1.8)
(2.3)
(1.3)
(1.3)
(2.5)
(0.7)
(3.4)
(4.1)
(6.8)
Consensus 2016
2.5
2.6 
1.9
1.9 
2.5
2.4 
1.5
1.5 
1.8
1.7 
2.5
1.9 
0.6
1.1 
3.5
3.9 
4.3
4.6 
6.8
6.3 
Prev.
(2.9)
(2.2)
(2.7)
(1.7)
(2.1)
(2.1)
(1.8)
(4.1)
(4.7)
(6.4)
Consensus 2017
2.9
2.8
2.1
1.9
2.6
2.1
1.7
1.6
1.9
2.1
2.4
1.6
1.3
1.5
4.0
4.2
4.8
5.2
6.5
6.2
Prev.
(2.9)
(0.5)
(0.6)
(0.0)
(0.2)
(0.0)
(1.1)
(7.0)
(4.8)
(1.4)
Consensus 2016
3.0
3.7 
0.3
1.4 
0.2
1.6 
0.1
1.3 
0.3
1.5
0.1
1.3 
0.8
1.0 
7.6
7.4 
4.4
3.6 
1.6
1.9 
Prev.
(3.3)
(1.7)
(2.3)
(1.1)
(1.5)
(1.6)
(1.1)
(6.1)
(3.8)
(2.0)
Consensus 2017
3.7
3.9
1.4
1.9
1.8
2.1
1.1
1.6
1.4
1.6
1.4
2.2
0.8
1.8
7.4
7.3
3.6
3.4
2.1
2.1
Inflation CPI
y/y%
World
Advanced*
US
Eurozone
Germany
UK
Japan
Total Emerging**
BRICs
China









Interest rates
% (Month of Dec)
US***
UK
Eurozone
Japan
China
Market
0.44
0.58
-0.14
0.18
-
2016
Prev.
1.25
(1.25)
1.00  (1.50)
0.05
(0.05)
0.10
(0.10)
3.50  (4.00)
Market
1.09
0.94
-0.20
0.16
-
2017
2.00
1.25
0.25
0.10
3.00
Market
1.68
1.41
1.41
0.72
-
Other monetary policy
(Over year or by Dec)
US QE ($Bn)
EZ QE (€Bn)
UK QE (£Bn)
JP QE (¥Tn)
China RRR (%)
Key variables
FX (Month of Dec)
USD/GBP
USD/EUR
JPY/USD
GBP/EUR
RMB/USD
Commodities (over year)
Brent Crude
53.5

2016
4507
1369
375
404
15.00
Prev.
(1.53)
(1.08)
(120.0)
(0.71)
(6.30)
Y/Y(%)
-1.9
-10.7
0.1
-9.0
3.2
(55)
-4.2
Prev.
 (4522)
 (1189)
(375)
 (406)
 16.00
2016
1.50
1.02
120.0
0.68
6.60 
48.5

2017
4525
1369
375
404
13.00
Prev.
(1.50)
(1.02)
(120.0)
(0.68)
(6.40)
Y/Y(%)
-2.0
-5.6
0.0
-3.7
3.1
2017
1.50
1.02
115.0
0.68
6.80
Y/Y(%)
0.0
0.0
-4.2
0.0
3.0
(55)
-9.4
54.6
12.6
Source: Schroders, Thomson Datastream, Consensus Economics, November 2015
Consensus inflation numbers for Emerging Markets is for end of period, and is not directly comparable.
Market data as at 13/11/2015
Previous forecast refers to August 2015
* Advanced m arkets: Australia, Canada, Denmark, Euro area, Israel, Japan, New Zealand, Singapore, Sw eden, Sw itzerland, United Kingdom
United States.
** Em erging m arkets : Argentina, Brazil, Chile, Colombia, Mexico, Peru, Venezuela, China, India, Indonesia, Malaysia, Philippines,
South Korea, Taiw an, Thailand, South Africa, Russia, Czech Rep., Hungary, Poland, Romania, Turkey, Ukraine, Bulgaria,
Croatia, Latvia, Lithuania.
*** The forecast for US policy interest rates w as updated this month, w ith the previous forecast refering to the August update.
21
December 2015
For professional investors only
Updated forecast charts – Consensus Economics
For the EM, EM Asia and Pacific ex Japan, growth and inflation forecasts are GDP weighted and
calculated using Consensus Economics forecasts of individual countries.
Chart A: GDP consensus forecasts
2015
2016
%
8
%
8
7
7
EM Asia
6
EM Asia
6
5
EM
5
EM
4
4
Pac ex Jap
Pac ex Jap
US
3
UK
2
3
Eurozone
Eurozone
2
1
1
Japan
0
Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15
0
US
UK
Japan
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
Chart B: Inflation consensus forecasts
2015
2016
%
6
%
6
EM
5
5
4
4
EM Asia
3
EM
Pac ex Jap
EM Asia
3
UK
2
Pac ex Jap
1
Eurozone
Japan
US
0
-1
Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15
2
US
UK
1
Eurozone
Japan
0
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
Source: Consensus Economics (November 2015), Schroders.
Pacific ex. Japan: Australia, Hong Kong, New Zealand, Singapore.
Emerging Asia: China, India, Indonesia, Malaysia, Philippines, South Korea, Taiwan, Thailand.
Emerging markets: China, India, Indonesia, Malaysia, Philippines, South Korea, Taiwan, Thailand, Argentina, Brazil,
Colombia, Chile, Mexico, Peru, Venezuela, South Africa, Czech Republic, Hungary, Poland, Romania, Russia, Turkey,
Ukraine, Bulgaria, Croatia, Estonia, Latvia, Lithuania.
The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own
assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to
our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors. The views and opinions contained herein
are those of Schroder Investments Management’s Economics team, and may not necessarily represent views expressed or reflected in other Schroders
communications, strategies or funds. This document does not constitute an offer to sell or any solicitation of any offer to buy securities or any other instrument
described in this document. The information and opinions contained in this document have been obtained from sources we consider to be reliable. No
responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the
Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and
information in the document when taking individual investment and/or strategic decisions. For your security, communications may be taped or monitored.
22