28 August 2014
For professional investors only
Schroders
Economic and Strategy Viewpoint
Keith Wade
Chief Economist and
Strategist
Azad Zangana
European Economist
Craig Botham
Emerging Markets
Economist
Forecast update: recovery continues, but headwinds persist (page 2)
 We have trimmed our global growth projections for 2014 and 2015 to 2.6%
and 2.8%, a sluggish outlook by the standards of past cycles. The 2014
downgrade reflects some base effects from a poor first half and modest cuts
to H2 in the US and Eurozone. For 2015 we believe structural headwinds will
persist, not least a weaker supply side performance in the US due to adverse
trends in demographics and productivity. We see past disappointments on
US growth as more fundamental than just a consequence of unfortunate
events.
 Such an outlook means that US unemployment falls further and inflation is
likely to pick up in 2015 as cost pressures build, prompting the Federal
Reserve (Fed) to start to normalise rates from mid-year. The Bank of England
(BoE) is likely to join the Fed in tightening, but the European Central Bank
(ECB) and Bank of Japan (BoJ) are expected to increase stimulus.
 Our scenario risks remain tilted to the downside with Eurozone deflation and
a deterioration in the Russia-Ukraine crisis the greatest ‘known unknowns’.
Europe: downside risks rise (page 8)
 Weak Eurozone growth and weaker inflation are a concern, leading us to
downgrade our growth and inflation forecasts. However, markets appear to
be buoyant with speculation that the ECB might unveil its own quantitative
easing (QE) programme.
 The UK continues to buck the trend in Europe with ongoing strong growth. It
may see a slight slowdown towards the end of the year as pay growth
continues to be weak and the housing market slows, however, the Bank of
England is likely to continue to prepare markets for eventual increases in
interest rates.
EM forecast update: politics and policy (page 13)

A mix of policy and politics have driven our revisions to EM forecasts this
time, with sanctions in Russia, elections in Brazil, intervention in China and
reform efforts in India all playing a part.
Chart: Global growth upswing intact
Contributions to World GDP growth (y/y)
7
6
5
4
4.5 4.1 4.1
4.1
3.5
4.9
4.9
4.5
4.0
2.8
3
5.0 5.1
4.6
4.5
3.7
2.9
2.5
3.4
2.6 2.6 2.6 2.8
2.3
2
1
0
-1
-1.2
-2
-3
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
US
Europe
Japan
Rest of advanced
BRICS
Rest of emerging
Source: Thomson Datastream, Schroders. 27 August 2014. Previous forecast from May 2014. Please
note the forecast warning at the back of the document.
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Forecast update: recovery continues, but headwinds persist
Growth
Global growth
forecast trimmed
for 2014 and 2015
We have trimmed our global growth forecasts for 2014 and 2015 by 0.2% to 2.6% and
0.1% to 2.8% respectively. This compares with an outcome of 2.6% in 2013 and paints
a picture of a sluggish world economy when compared with the cycles of the 1990s or
2000s when global growth averaged around 4% per annum at this stage of the
upswing (see chart on front page). The downgrade to 2014 largely reflects base
effects from a weak H1, although there have been minor downgrades to H2 in the US
and Eurozone.
For 2015, our forecasts have also been reduced in both the advanced and emerging
economies. In the former this reflects the ongoing headwind from debt deleveraging in
both the consumer and public sectors and weak productivity growth on the supply
side. Meanwhile, several EM economies face inflation and rebalancing pressures such
that growth remains sub-trend. The China forecast for 2014 has been raised to 7.3%
to reflect the effect of stimulus packages, but remains at 6.8% in 2015.
Gradually improving demand from the US and Europe will help EM exports, but
progress will be slower than in previous cycles. Similarly, the lack of a robust upturn in
Chinese demand will weigh on commodity producers such as Brazil, Indonesia and
Russia. The latter also faces the challenge of becoming increasingly isolated from the
world trading and financial system as the dispute with the Ukraine continues.
Inflation
Inflation to benefit
from lower
commodity prices
in near term, but
pick up thereafter
Despite trimming the growth forecast, our inflation projections are little changed with a
mix of upgrades and downgrades. The overall global figure for 2014 is marginally
higher at 3.1% as a result of the increase in consumption tax in Japan (which brought
a greater feed through to prices than expected), but elsewhere we have brought our
forecasts down, particularly in the UK and Eurozone. In the near term inflation news
around the world should be benign as recent falls in commodity prices feed into the
CPI index (chart 1). This in turn will support consumer spending and activity in the
second half of the year.
Chart 1: Commodity prices indicate dip in G7 inflation
5
80
4
60
3
40
2
20
1
0
0
-20
-1
-40
-2
2004
-60
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
G7 Headline CPI (%, y/y), lhs
S&P GSCI Commodity Spot (%, y/y), rhs
Source: Thomson Datastream, Schroders 27 August 2014
In 2015 the slight increase in global inflation to 3.2% is driven by the US where we
expect rent and wage costs to pick up. We do not see productivity growth improving
sufficiently to offset higher wages in the US with the result that unit wage costs
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accelerate (see last month's Viewpoint). Slightly higher inflation in the emerging world
also boosts the global aggregate.
Relative to consensus, we are below on growth, particularly in 2015 with consensus at
3.2% compared to our forecast of 2.8%. In some respects we would see this as
learning from experience, particularly in the US where forecasts for growth (both our
own and the market's) have been persistently too optimistic in each of the past four
years. The result has been a series of steady downgrades in the consensus GDP
forecast as the year has progressed, particularly in the US (see chart 2).
Economists have
been consistently
too optimistic on
US growth
Chart 2: The evolution of US GDP forecasts - spot the pattern
Forecast for year average (%)
3.5
3.0
2.5
2.0
1.5
2010
2011
2011
2012
2013
Date of consensus forecast
2012
2013
2014
2014
2015
Source: Thomson Datastream, Consensus Economics, Schroders. 27 August 2014.
If our current forecasts for US growth are correct then the consensus will see further
downgrades as we move through 2015. The combination of weaker than expected
growth, but continued falls in unemployment strongly suggests that the trend rate of
growth in the US has slowed. Those looking for regular US growth of 3% plus are
likely to be disappointed as we believe slower productivity growth and less favourable
demographics mean the sustainable path for US growth has fallen compared to the
past two cycles.
An unfortunate
series of events or
something more
fundamental?
On the demand side, credit growth is likely to remain subdued given a reluctance to releverage on the part of households and continued caution from a more heavily
regulated banking sector. These are effects that are very much in line with the
Reinhart and Rogoff analysis of how economies perform after a financial crisis. The
slowdown in productivity and working population growth will be an added feature of
this cycle, reinforcing the move to weaker growth. Overall we see trend growth for the
US at 2 - 2.5% compared with around 3% in the past. Note that our interpretation
differs from those who see the recent weakness of US GDP growth as a consequence
of a series of one-off events such as bad weather, government shutdown, etc. In our
view it is more fundamental.
Policy: divergence ahead
For the US we see the Fed as on target to end QE by October and raise interest rates
from June 2015. This is expected to occur despite our sub-consensus growth view as
we see unemployment continuing to fall and wages picking up, thus increasing
inflationary pressure. The Fed will have to make a judgement, but modest growth
combined with a tighter labour market and a pick-up in core inflation should mean that
the normalisation process can begin.
3
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In the Eurozone, we expect the ECB to monitor the impact of recently announced
measures to reduce bank funding costs before taking further action. There is a
possibility of QE whereby the central bank purchases Asset Backed Securities,
however, as the economy is expected to escape deflation we do not see a strong case
for asset purchases. It is difficult to see what would be achieved through purchases of
sovereign bonds given the current low level of yields in the region. The hope would be
that such action would help weaken the euro, but this may well come about on our
central view as the interest rate differential moves in favour of the US. Divergence in
monetary policy remains a key theme of the forecast, a view reinforced by the
performance of inflation in the US and Eurozone (chart 3).
Chart 3: Inflation divergence between the US and Eurozone
Fed and BoE are
set to tighten,
whilst ECB, BoJ
and PBoC keep
policy easy
%, y/y
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
98
99
00
01
02
03
Difference
04
05
06
07
08
Core US CPI
09
10
11
12
13
14
Core Eurozone CPI
Source: Thomson Datastream, Schroders. 27 August 2014.
In Japan, we have pushed out an acceleration in QQE (qualitative and quantitative
easing) until October when the BoJ is expected to downgrade growth expectations.
Although there has been optimism about increased incomes in Japan as a result of
higher employment and some modest wage gains, the increase in consumption tax
has pushed real household income back down. Combining wage and job growth
indicates household earnings are rising at just under 2%, compared with current CPI of
3.6% (chart 4).
Chart 4: Higher inflation offsets labour market progress in Japan
%, y/y
8
6
4
2
0
-2
-4
-6
'91
'93
'95
'97
'99
'01
'03
'05
CPI inflation
Wage inflation
Source: Thomson Datastream, Schroders, 25 August 2014.
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'07
'09
'11
Earnings growth
'13
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For the UK, we expect the first rate hike in February 2015 as a result of stronger
activity. China is expected to leave the reserve requirement ratio (RRR) unchanged,
but pursue other means of stimulating activity in selected sectors. Europe and EM are
discussed in more detail below.
Scenario analysis: deflationary bias remains
We continue to run with our main scenarios (which are described on page 21), but
have swapped out the "Trade war" (based on an escalation of the island dispute
between Japan and China) for a new scenario called "Productivity recovers". The latter
represents a bounce back in productivity from current low levels and results in stronger
growth and lower inflation than in the baseline (see chart 5). This is not to say that the
risks in East Asia have faded completely, but at present the island dispute has moved
out of the spotlight.
2015 Inflation vs. baseline forecast
Scenarios tilt
toward lower
growth and
inflation
Chart 5: Scenario risks around the baseline
+2.0
+1.5
G7 boom
+1.0
Capacity limits
bite
+0.5
Russian rumble
+0.0
Secular
stagnation
-0.5
Eurozone
deflation
-1.0
-1.5
Reflationary
Stagflationary
-1.5
Productivity
recovers
China hard
landing
Deflationary
-2.0
-2.0
Baseline
Productivity boost
-1.0
-0.5
+0.0
+0.5
+1.0
2015 Growth vs. baseline forecast
+1.5
+2.0
Source: Schroders. August 2014 forecast. Please note the forecast warning at the back of the
document.
Geopolitical risk
intensified by the
Russia-Ukraine
crisis
Unfortunately, geopolitical risk remains very much centre stage with the RussiaUkraine crisis intensifying following the fatal strike on Malaysian airlines flight MH17,
allegedly by pro-Russian separatists. Sanctions from both sides have been stepped
up, and although the Russian economy has been worst affected, there is a risk that
European confidence is hit on concerns that the situation will deteriorate further,
leading to the loss of energy supplies.
Meanwhile, President Putin's approval rating has soared to a record 83% in July
according to Gallup (chart 6) and such overwhelming support for the Russian
president convinces us that he will continue to maintain the pressure on Ukraine
through a combination of rhetoric and support for the separatists. Military intervention
cannot be ruled out and we have increased the probability attached to our "Russian
rumble" scenario to 6% (see chart 7). The cost of energy is expected to soar in such a
scenario and we represent this as a stagflationary shock to the world economy with,
not surprisingly, the Eurozone being most vulnerable.
5
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Chart 6: Putin's popularity rating soars on Ukraine crisis
90%
83%
80%
83%
77%
74%
70%
65%
60%
50%
54%
54%
2012
2013
40%
2008
2009
2010
2011
2014
Putin's approval rating*
*Vladimir Putin’s approval rating as prime minister pre-2012 and president since then.
Source: Gallup, 7 August 2014.
Chart 7: Baseline and scenario probabilities*
Eurozone
deflation, 6%
G7 boom, 5%
Productivity
recovers, 2%
Capacity limits
bite, 5%
Baseline, 65%
China hard
landing, 4%
Russian rumble,
6%
Other, 2%
Secular
stagnation, 5%
*Probabilities are mutually exclusive. Source: Schroders. August 2014 forecast. Please note the
forecast warning at the back of the document.
Staying with the Eurozone, we have raised the probability on the "Eurozone deflation"
scenario given recent developments with growth appearing to falter whist inflation
prints remain low. Offsetting these increases have been reductions in the probabilities
attached to the "G7 boom", "capacity limits bite" and "China hard landing" scenarios.
Overall the balance of probabilities has turned negative on growth and remains firmly
negative on inflation, an indication that the tail risks lie in a deflationary direction (chart
7 & 8). In this respect the risk on interest rates is to the downside with central banks
likely to maintain stimulus in the face of a deflationary outcome.
6
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Chart 8: Growth and inflation risks
Balance of probabilities*
5
0
-5
-10
-15
-20
-25
Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14
Inflation
Growth
*Probabilities are mutually exclusive. Source: Schroders. August 2014 forecast. Please note the
forecast warning at the back of the document.
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Europe: downside risks rise
Weak Eurozone growth and even weaker inflation are worrying. Markets are however
buoyant with speculation the ECB may embark on QE in the near future. Meanwhile,
the UK is bucking the trend in Europe with far stronger growth, just as the BoE warns
of the possibility of rises in interest rates.
Weak growth in Q2
The Eurozone
stagnated in the
second quarter as
most of the core
economies
underperformed
expectations
Official estimates show the Eurozone stagnated in the second quarter of the year
following poor performance in core Europe. We had previously warned of weakness in
official monthly industrial production data, but it seems the latest figures had still
disappointed consensus expectations. The results mean that this has been the worst
quarter for the monetary union since the first quarter of 2013 and raises questions over
the direction of growth heading into the second half of the year.
Within the Eurozone, Germany surprised most by posting growth of -0.2% quarter-onquarter, while France also disappointed by stagnating for the past six months (chart 9).
Meanwhile, early estimates for Italy revealed that it had slipped back into recession
with a contraction of -0.2%. However, the Eurozone aggregate was supported by
some strong performances elsewhere, with both Spain and Portugal recording 0.6%
growth, and Netherlands achieving 0.5% growth. The UK economy stood out, posting
the strongest growth figures of the major European economies for the second quarter
in a row.
Chart 9: Recent European GDP growth
%, Q/Q
1.00
0.80
0.60
0.40
0.20
0.00
-0.20
-0.40
-0.60
-0.80
Q1
Ger
Ita
Q2
EZ
Fra
Bel
Fin
Aus
Swe Neth Spa
Por
UK
Source: Thomson Datastream, Eurostat, Schroders. 22 August 2014.
Seasonal factors
are part of the
explanation, but
Ukraine-Russia
tensions may have
had an indirect
impact
While the aggregate Eurozone GDP results are disappointing, it is worth remembering
that the first quarter was unusually strong thanks to a very mild winter which boosted
construction activity, particularly in Germany. Therefore, a pull-back in activity was
always likely in the second quarter and should mean that the third quarter is stronger.
However, the seasonal factors do not fully explain the latest weakness recorded.
Another factor which may have already had an indirect impact on growth is the
escalating crisis in Ukraine. Russia recently announced a trade embargo on a range of
food imports from Western economies. Given its proximity and that it is the largest
exporter of agricultural produce to Russia, Europe is likely to feel the greatest effect
from the embargo. However, the true impact on Europe is likely to be very small. 6.9%
of total EU exports go to Russia, but when isolating agricultural goods and livestock,
the share of total exports falls to just 0.5% - barely worth 0.1% of GDP. In any case,
the embargo was introduced after the end of the second quarter and so will not have
had a chance to impact Eurozone exports yet. However, tensions on the border
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between Ukraine and Russia may have already hit confidence and prompted
corporates to hold back or delay capital investment more recently.
The Russian
rumble scenario
has seen an
increase in
probability
The bigger danger for investors is whether the exchange of trade sanctions continues
to escalate, and whether it leads to embargoes on trade in oil and natural gas. Russia
and Europe are highly reliant on the crucial supply and sales of Russian energy.
Without it, European production and consumption could be badly hit with skyrocketing
prices, while Russia would see a collapse in its most important revenue stream. We
introduced the 'Russian rumble' risk scenario last quarter in order to highlight the risk.
Three months on, as argued above, it seems that the probability of the scenario
playing out has risen.
Low inflation - policy response?
Low market
inflation
expectations have
caught the ECB's
attention…
Against the backdrop of weak growth in the Eurozone, inflation has also been
disappointingly low. Annual HICP inflation for the Eurozone fell to just 0.4% in July - its
lowest level since the midst of the financial crisis in 2009. Food and energy price
deflation have been significant drags on the headline figure over the last year, as a
warm winter caused an excess build up of energy reserves, while bumper harvests
have pushed food prices lower. Excluding energy, food, alcohol and tobacco,
Eurozone inflation is higher at 0.8%, unchanged since May. The combination of lower
inflation and weaker than expected growth has prompted investors to lower their
medium-term inflation expectations. The ECB's favourite measure of this is the zero
coupon 5yr5yr inflation swap - which recently fell below 2% for the first time (chart 10).
Chart 10: Lower inflation expectations drive bond yields lower
%
6
5
4
3
2
1
0
2007
2008
2009
2010
2011
Zero coupon EU 5yr5yr inflation swap
2012
2013
2014
German bund (10yr) yield
Source: Bloomberg, Schroders. 27 August 2014.
…raising hopes of
QE in the near
future, and lower
bund yields.
ECB President Mario Draghi acknowledged the low rate of market inflation
expectations in his speech at the annual central bank symposium in Jackson Hole
(22nd of August). Speaking about unemployment in the euro area, Draghi warned that
while much of the deflationary factors of late can be explained by external and
temporary factors (energy, food, strong euro): "…if this period of low inflation were to
last for a prolonged period of time the risk to price stability would increase". Draghi
also said that shorter term inflation expectations have fallen further, which means that
real interest rates in the euro area have also risen. Normally this would prompt a policy
response from the ECB and indeed, Draghi's next statement has since prompted
speculation that more might follow: "The Governing Council will acknowledge these
developments and within its mandate will use all the available instruments needed to
ensure price stability over the medium term."
Those comments appear to have been interpreted as the ECB preparing for QE, and
9
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in particular, purchases of government bonds. This has pushed sovereign bond yields
to new lows, with the yield on the German bund falling below 1% in recent days (chart
10).
While Draghi's speech was clearly dovish, especially with regards to fiscal policy
possibly playing a bigger role in boosting demand (a significant deviation from his
usual script), we struggle to see the ECB announcing more aggressive measures like
sovereign debt QE, when extra liquidity to banks (through the TLTROs) is about to be
released next month, and possible asset-backed securities purchases are still being
worked on. Markets may be in for a disappointment at the September ECB meeting.
Eurozone forecast update
We have lowered the forecast for Eurozone GDP growth in the coming quarters, and
slightly in 2015. A combination of upward revisions to the second half of 2013 and the
disappointing results for the second quarter mean that the forecast for 2014 growth is
now 0.8% compared to 1% last quarter and 1% consensus expectations. The forecast
for growth in 2015 has been lowered to 1.2%, compared to 1.4% previously, and 1.5%
consensus.
Meanwhile, the forecast for inflation has also been lowered to reflect the lower inflation
of late, but also the recent falls in the price of natural gas, which has yet to feed
through into household energy bills. Whereas previously we had forecast headline
HICP to head back above 1% by the end of the year, this now looks unlikely. The
forecast for 2014 Eurozone inflation is now 0.7%, compared to the previous forecast of
0.9%, and consensus estimates of 0.6%. The forecast for 2015 inflation has been
lowered to 1.1%, from a previous forecast of 1.2%, and a consensus of 1.1%.
Chart 11: Eurozone GDP forecast
We have
downgraded the
forecast for
Eurozone growth
and inflation for
2014 and 2015…
Chart 12: Eurozone inflation forecast
%, Q/Q
+0.6
%, Y/Y
+3.0
+0.4
+2.5
+0.2
+2.0
+0.0
+1.5
-0.2
HICP
inflation
forecast
+1.0
Real GDP
forecast
-0.4
-0.6
+0.5
+0.0
i ii iii iv i ii iii iv i ii iii iv i ii iii iv
2012
2013
Current forecast
2014
2015
Previous forecast
i ii iii iv i ii iii iv i ii iii iv i ii iii iv
2012
2013
Current forecast
2014
2015
Previous forecast
Source: Thomson Datastream, Schroders. 27 August 2014. Previous forecast from May 2014.
Please note the forecast warning at the back of the document.
We continue to monitor the risk of deflation in the Eurozone and have run a 'Eurozone
deflation' scenario for some time as mentioned above. We have not seen households
change their behaviour in response to lower price inflation. If we were to see
households delaying consumption in anticipation of lower prices, then we would judge
the risk of deflation to be greater, and would expect the ECB to follow up with far more
aggressive action (QE). For now, households are seeing higher disposable income
thanks to the lower rates of inflation, which is helping to boost retail spending.
Within the Eurozone, the main downgrade has been to German growth (table 1). The
contraction in the second quarter along with softer leading indicators suggests a
weaker than previously forecast outlook for the second half of the year. In addition, we
have downgraded the forecast for France and Italy, for both this year and next. France
continues to struggle to implement structural reforms. Hopefully the latest reshuffle of
10
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the cabinet will help push the reform agenda forward, but with austerity ongoing, it is
difficult to see much upside in the near-term.
Table 1: Eurozone GDP forecast
The biggest
downgrade is for
Germany, only
Spain has seen an
upgrade of the big
four
2014
Prev.
2015
Prev.
Germany
1.6
2.2
1.9
2.3
France
0.4
0.6
0.8
0.9
Italy
-0.3
0.0
0.4
0.6
Spain
1.2
1.0
1.4
1.3
Eurozone
0.8
1.0
1.2
1.4
Source: Schroders. 27 August 2014. Previous forecast from May 2014. Please note the forecast
warning at the back of the document.
In Italy, Prime Minister Renzi has managed to win a vote on political reforms, which
will make it harder for smaller parties to block progress on economic reforms. This is
seen as the first stage in launching a raft of economic reforms over the next year, but
is likely to be slightly negative in the near-term. Among the big four member states,
only Spain is being upgraded as we recognise the upside risk from the impact of
reforms implemented over the past few years. Unemployment in Spain is slowly falling,
while the real effective exchange rate shows that Spain has significantly improved its
competitiveness.
UK forecast update
The UK continues
to power ahead,
but can expect a
small slowdown in
the second half of
the year
The growth
forecast for the UK
has been revised
up slightly, while
inflation revised
down
In the UK, the strong start to the year continued into the second quarter as leading
indicators maintained healthy readings. Unemployment has continued to fall at a
steady pace, while good household spending growth has been joined by a notable pick
up in corporate investment. Looking ahead, there are signs that the recent pace of
growth may not be sustainable. Average household earnings have been falling in real
terms since the start of the financial crisis, but more alarmingly, the latest official
figures showed wages falling in nominal terms as well. This suggests that the recent
growth in household spending is being paid for by reduced savings. In addition, a
sharp rise in house prices coupled with tighter lending criteria introduced by the Bank
of England appear to have slowed demand in the market recently. This is important as
a large part of the improvement in household spending over the past year appears to
be linked with the pick up in activity in the housing market. Finally, the contribution
from net trade with the Eurozone is likely to be smaller given the downgraded outlook
mentioned above. For 2015, the general election could prompt companies to delay
business investment, especially if a new government is elected.
Overall, the forecast for UK growth is largely unchanged - revised up to 3% for 2014,
but expected to slow to 2.5% in 2015 (chart 13). Risks are skewed to the downside as
highlighted by our risk scenarios. An additional UK-centric risk scenario is one where
Scotland votes for independence on the 18th of September. We would expect this to
be a stagflationary scenario with lower growth due to political uncertainty, but higher
inflation as investors drive GBP lower. See the Schroders Talkingpoint: "Scottish
independence: economic and political challenges", published on 3rd of July 2014.
For inflation, like the Eurozone forecast, we have downgraded the near-term outlook
on the back of the fall in the price of natural gas. This should feed through into lower
home energy bills this winter, whereas most households saw gas and electricity bills
rise at the end of 2013. CPI inflation is forecast to average 1.6% in 2014 and 2.2% in
2015.
11
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Chart 13: UK growth forecast
%, Q/Q
+1.0
Chart 14: UK inflation forecast
%, Y/Y
+4.0
+0.8
CPI
inflation
forecast
+3.5
+0.6
+3.0
+0.4
Real GDP
forecast
+0.2
+0.0
+2.0
-0.2
+1.5
-0.4
i ii iii iv i ii iii iv i ii iii iv i ii iii iv
2012
2013
2014
2015
Current forecast
Meanwhile, Carney
continues to
confuse markets warning of interest
rate hikes, then
giving dovish
signals
+2.5
Previous forecast
+1.0
i ii iii iv i ii iii iv i ii iii iv i ii iii iv
2012
2013
2014
2015
Current forecast
Previous forecast
Source: Thomson Datastream, Schroders. 27 August 2014. Previous forecast from May 2014.
Please note the forecast warning at the back of the document.
As for monetary policy, we revised our forecast for BoE interest rates in June after
Governor Mark Carney delivered a hawkish Mansion House speech. Interestingly, since
that speech, signals from the Bank have been very mixed. Carney's warning that the
market was not pricing in a big enough probability of a rise in interest rates before the end
of the year brought forward market expectations for the first rate rise to November (2014).
Indeed, the market was pricing in 20-25 basis points of higher interest rates by December
2015 (chart 15). Since then, more dovish comments in combination with no change in
voting amongst members of the monetary policy committee (MPC) brought expectations
back down. The Bank's quarterly Inflation Report in August also provided more dovish
signals as while the bank revised up its growth forecast, its latest assessment of spare
capacity suggested there was more slack than previously thought. The report pushed
expectations for the first rate hike back out to 2015, and even when the August MPC
minutes revealed that two members of the committee had voted for a rise in interest rates,
market expectations remained sanguine. In fact, market pricing for interest rates at the end
of 2015 is now below where it was before Carney's Mansion House speech.
Chart 15: Euro-Sterling 3-month - December 2015 future contract
%
2.1
2.0
Carney's
Mansion
House Speech
BoE Inflattion
Report
1.9
Aug MPC
Minutes
1.8
1.7
1.6
1.5
1.4
May
June
July
Source: Thomson Datastream, Schroders. 26 August 2014.
August
At this stage, we are happy to continue to forecast the first rate rise in February 2015,
with 25bps of hikes per quarter. However, the risks to our forecast are skewed towards
slower and later rises, not only because of the lack of pay growth, but also our forecast
for inflation towards the turn of the year.
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EM forecast update: politics and policy
Downward
revisions as
macro disappoints
and politics
weighs on growth
Revisions to our BRIC forecasts have been somewhat mixed this quarter, reflecting
divergent geopolitical risks and data surprises. The most notable changes come in
Russia and Brazil. For Russia the escalation in Ukraine and resultant sanctions, have
done much to diminish the growth outlook, while its own import sanctions will see a
spike in food price inflation. Meanwhile, Brazilian data has been much weaker than
expected and it is difficult to see things improving much this year. We have cut our
forecasts by 0.4% and 1.1% respectively.
Table 2: Summary of BRIC forecasts
GDP
% per
annum
2014
2015
Prev.
Prev.
China
7.3 ↑
7.1
6.8 →
6.8
Brazil
0.6 ↓
1.7
1.0 ↓
1.9
India
5.0 →
5.0
5.5 →
5.5
Russia
0.2 ↓
0.6
0.5 ↓
1.4
2014
2.3 ↓
6.4 ↓
7.7 ↑
8.1 ↑
Inflation
2015
Prev.
2.7
3.0 ↓
6.6
6.2 ↓
7.1
6.3 ↑
6.3
7.0 ↑
Prev.
3.1
6.3
6.1
5.8
Source: Bloomberg, Thomson Datastream, Schroders. 20 August 2014. Previous forecast from May
2014. Please note the forecast warning at the back of the document.
China: frontloading growth
Stimulus has
helped in China…
Chinese growth has been revised upwards for 2014, as the mini-stimulus packages
and continued commitment to the 7.5% target this year have provided a support to
activity. Second quarter growth came in stronger than expected at 7.5% year-on-year,
assisted by policy support, particularly for investment. This has come in two forms:
accelerated expenditure on infrastructure by the government, and assorted credit
measures to encourage continued extension of lending to infrastructure and social
housing projects. This saw investment recover in May and June after showing early
signs of deceleration, led particularly by infrastructure investment (measured in chart
16 by Transport and Communications investment).
Chart 16: Investment (and growth) in China has benefited from policy support
Fixed asset investment (%, y/y, 3m-MA)
50
40
30
20
10
0
-10
2010
Total
2011
Manufacturing
2012
Real estate
2013
2014
Transport & Communications
Source: Thomson Datastream, Schroders. 26 August 2014
…but is already
fading
However, July data indicated that these stimulus efforts were already fading, with
investment growth dropping back markedly. Weakness in the property sector has also
been gathering momentum, in spite of a relaxation of purchase restrictions and
government pressure to ease mortgage lending. With weak private demand the impact
of government stimulus has a smaller multiplier than before, and it looks like it will take
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bigger and bigger injections to achieve the same level of growth. It would make sense
to lower the national growth target in 2015, and to allow some flexibility. Policymakers
seem to recognise already that stimulus measures might cause instability; the central
bank has said as much about the targeted RRR cuts it has implemented, ruling out
further similar measures. This would also do much to reassure investors about
Chinese stability and growth, supporting efforts to internationalise the renminbi and
encourage non-speculative capital inflows. It is for this reason that we leave our 2015
forecast unchanged at 6.8%.
A potential upside risk to our growth number is a strong export recovery, but again it
might be better to use external growth supports as an opportunity to reduce domestic
stimulus and the risks of instability it poses.
Further monetary
stimulus is likely,
and as yet
unconstrained by
inflation
On the subject of monetary stimulus, we have revised our forecast for a RRR cut this
year. We now believe the RRR will be left unchanged, in part because the more
targeted monetary stimulus measures have already amounted to more than a 50bps
cut in the effective RRR. Furthermore, the central bank has stated its preference for
other policy measures, in particular its new Pledged Supplementary Lending (PSL)
scheme, which provides credit to banks lending to the "right" parts of the economy
(e.g. social housing). Finally, RRR cuts alone are of limited effectiveness in a system
where banks are already nudging up against loan to deposit ratio (LDR) limits. Further
LDR easing would probably be more effective than a RRR cut, though the two in
conjunction are a possible option - if not for the fear of rising financial fragility.
There is at least policy space for monetary stimulus, given the low level of inflation.
Headline inflation remains subdued at 2.3%, and has not exceeded 2.5% this year.
Modest food price inflation has helped, and there is no sign of building pressures at
present. Producer price inflation remains negative, but the deflationary pressures are
easing somewhat, suggesting that spare capacity is gradually being squeezed out
(chart 17).
Chart 17: Inflation is not presently a binding constraint on monetary policy
y/y
20%
15%
10%
5%
0%
-5%
-10%
2009
2010
2011
2012
Headline CPI inflation
Source: Thomson Datastream, Schroders. 26 August 2014
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2013
CPI Food
2014
PPI
28 August 2014
For professional investors only
Brazil: political uncertainty centre stage
Activity has taken
a turn for the
worse in Brazil
Weaker data from Brazil in the second quarter has prompted a downgrade of our
growth expectations for this year and next. Second quarter GDP had not been
released at the time of writing, but higher frequency indicators are suggestive of a
contraction (chart 18). This is despite any positive impact from the World Cup and the
higher pre-election spending embarked upon by President Dilma Rouseff. Fiscal
outlays are now limited by law to prevent excessive populism, so the scope for further
fiscal stimulus in the third quarter is limited. Post-election, a tighter fiscal stance seems
more likely than a looser one, as the victor will have to address the deterioration of
Brazil's fiscal account and its credit rating. Meanwhile, private sector activity has
limited support: the consumer is heavily indebted (and many of them are dropping out
of the labour force), commodity prices remain soft, regional neighbours are struggling
for growth (notably Argentina), and credit costs are rising. Public sector bank lending
has been climbing as the government attempts to compensate for declining private
sector provision, but this too will have to halt post-election, again because it threatens
Brazil's credit rating.
Chart 18: Brazilian economic activity has declined sharply
%, y/y
12
10
8
6
4
2
0
-2
-4
-6
04
05
06
07
GDP
08
09
10
11
12
13
14
Central bank GDP proxy
Source: Thomson Datastream, Schroders. 26 August 2014.
The central bank target rate seems set to remain high. Inflation has recently begun to
rollover (though it remains at the top of the target band), and with growth weakening
dramatically, pressure for further hikes is limited for now. However, hikes in regulated
prices lurk on the horizon, and the central bank has said “inflation should converge
towards the target in the final quarters of the forecast horizon [2016]”, and that its
strategy “does not contemplate a reduction in the monetary policy instrument”.
Hopes for a rebound next year are weak and rest on an improvement in the direction
of policy improving sentiment, a strengthening global recovery, and a bounce on the
low base effect from 2014. Clearly, risks are to the downside.
Campos' death
has changed the
electoral
landscape
On the political front, the tragic death of presidential candidate Eduardo Campos has
brought renewed uncertainty. Campos was in third place in opinion polls, but his
running mate (now heading the ticket), Marina Silva, represents a real threat to
incumbent Dilma Rousseff. One poll suggested she would be victorious in a runoff
vote. Generally speaking, Silva is a more market-friendly candidate than Rouseff,
espousing orthodox economics, but her environmental leanings could concern the
energy and agribusiness sectors. The market favourite would probably be Aecio
Neves, but at present, Silva looks more likely to win. This is still an improvement from
Rousseff, but the market reaction is harder to predict.
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Reforms important
for growth, but
facing obstacles
For professional investors only
India: steady progress
Key to watch, with regards to growth in India, is the progress of the new Modi
government in implementing reform. Not only can reforms provide practical boosts to
the economy via facilitating investment and greater efficiency, they can also boost
sentiment among investors and consumers alike. We think the latter is probably the
more powerful of the two effects so far, with the government pushing ahead on several
fronts, but less rapidly than some had hoped. Opposition is coming both from the
Congress party and within the government. The recent action by India in blocking a
World Trade Organization deal to defend their food subsidies is a disappointing sign
that the government is planning on placating, not facing down, this opposition.
As with Brazil, second quarter GDP has not yet been released. Unlike Brazil, however,
macroeconomic data have been improving in India, and even limited reform efforts are
boosting confidence. Recent industrial prints have shown a trend of strengthening
performance, while net exports remain healthy, if not outstanding. A profile of gradually
improving growth remains our base case for this year, with upside risks from export
performance. Monetary policy though looks set to remain a weight on the economy.
Chart 19: Indian macro indicators
%, y/y
50
Index
70
40
65
30
60
20
55
10
0
50
-10
45
2010
Monetary policy to
remain tight under
hawkish Rajan
-20
2011
2012
Manufacturing PMI, lhs
Industrial production, rhs
2013
2014
New orders
Car sales, rhs
Source: Thomson Datastream, Schroders. 27 August 2014
Despite the hopes of Indian business, we do not expect a cut to interest rates this
year. Since Raghuram Rajan took charge of the Reserve Bank of India (RBI) on the 4th
of September 2013, the RBI has become resolutely hawkish. The governor has
pushed for formal inflation targeting, and has set a target of 8% CPI inflation by
January 2015, and 6% by January 2016. Coupled with an improving current account
(aided by RBI gold import restrictions), this has seen the rupee strengthen around 10%
during Rajan’s tenure. Rajan has sounded consistently hawkish throughout, despite
increasing calls from business for rate cuts. The latest RBI meeting on the 5th of
August kept rates on hold at 8% and was accompanied by comments that upside risks
to inflation remain. Rate cuts seem extremely unlikely before next year. Inflation looks
to be on trend to fall below its 2014 target. There are near term risks arising from
weather-related concerns about food prices, but overall the impact of tighter monetary
policy on credit growth and wage growth deceleration are supportive of a lower
inflation outlook. Separately, the RBI is taking advantage of current rupee strength to
rebuild FX reserves. While this limits rupee strength for now, it will also act as a buffer
against possible weakness as US policy tightens. We expect the first rate cut in Q3 of
2015.
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Russia: suffering sanctions
Sanctions by US
and EU are hurting
growth…
This year each Viewpoint has been shortly followed by an escalation of the situation in
Ukraine and a worsening of Russia's growth outlook. The latest round of sanctions,
from the EU, US and Russia, have material implications for Russian growth and have
prompted a further downgrade to our forecast.
The EU’s “level three” sanctions hit the defence, energy and finance sectors, including
a ban on EU persons or companies buying, selling or providing services related to
issuance of new bonds, equities and similar financial instruments with maturity over 90
days issued by "state-owned Russian banks, development banks, their subsidiaries
and those acting on their behalf". Meanwhile, the US announced new sanctions
against the energy, arms and financial sectors.
The financial sanctions are the most significant of the EU’s measures, in terms of
economic impact. The central bank will act to support Russian banks hit by the
sanctions, and with reserves of around $410 billion, is well placed to do so. However,
some $80 billion in external debt is maturing this year, and the central bank is already
using its reserves to defend the ruble (reserves were over $45 billion lower in July,
year on year). Clearly this is not something that can be managed indefinitely.
Reflecting this, the central bank has already hiked rates 50bps to slow capital outflows,
and further hikes may be coming if the situation is not resolved. The cost of credit in
Russia will increase sharply, particularly as state-owned banks account for over half of
banking system assets, hitting already poor investment.
There are other negative effects too. Business and investor sentiment is likely to be
depressed further both by widening of the scale of sanctions as well as increased
uncertainty over potential further changes. Also, US restrictions on the export of
equipment and technologies for the oil sector are negative for investment in future
production, and hence state revenues (oil and gas account for half of federal budget
receipts).
…and Russian
sanctions are
impacting inflation
Meanwhile, Russia has imposed an embargo on a range of food imports from most
Western economies. The ban covers meat, fish, seafood, vegetables, fruit, milk and
dairy products from the US, EU, Australia, Canada and Norway, and follows three
rounds of Western sanctions. Regardless of the move’s political costs and benefits,
the ban will create economic costs for Russia. Domestic consumption exceeds
production for a number of the banned items, so Russia will not be able to fill the gap
domestically (plans to expand domestic production will take time to come to fruition
given the natural production cycle for agricultural produce). Instead, they will have to
seek out alternative providers. For some goods, Russia is particularly reliant on the
sanctioned countries. Over 50% of imports of pork, poultry, and dairy products, for
example, are now banned. Global production data suggests the rest of the world does
not produce enough to immediately meet Russian demand. Sharp price rises
consequently seem inevitable.
Inflation of course is already elevated in Russia (chart 20 on next page), and the
further inflationary impact from the import ban will add to pressure on the central bank
to extend its hiking cycle. The uncertainty generated by the sanctions has also led to
additional currency depreciation, adding to inflation pressures. At a time when
sanctions from the West have already pushed up financing costs and forced banks to
seek domestic financing, domestic interest rate hikes will have a greater impact than
usual. Credit and economic growth will suffer.
17
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Chart 20: Inflation in Russia
y/y, %
16
14
12
10
8
6
4
2
0
2010
2011
Headline inflation
2012
Core inflation
Source: Thomson Datastream, Schroders. 27 August 2014.
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2013
2014
Food inflation
28 August 2014
For professional investors only
Schroder Economics Group: Views at a glance
Macro summary – August 2014
Key points
Baseline

World economy on track for modest recovery as monetary stimulus feeds through and fiscal
headwinds fade in 2014. Inflation to remain well contained.
US rebounded in Q2 after weather related dip in Q1. Unemployment to fall faster than Fed expects,
wage and price growth to pick up as productivity remains sluggish. Fed to complete tapering of asset
purchases by October 2014. First rate rise expected in June 2015 with rates rising 25 bps per meeting
to 1.5% by year end.
UK recovery to be sustained by robust housing and consumer demand whilst economic slack should
limit the pick-up in inflation. Growth likely to moderate next year with general election and resumption
of austerity. Interest rates to rise in February 2015 and reach 1.5% by year end.
Eurozone recovery becomes more established as fiscal austerity and credit conditions ease in 2014.
ECB on hold after cutting rates and taking measures to reduce the cost of credit, otherwise on hold
through 2015. Deflation to be avoided, but strong possibility of QE (purchases of asset backed
securities) in response to deflation fears.
"Abenomics" achieving good results so far, but consumption tax has hit growth and Japan faces
significant challenges to eliminate deflation and repair its fiscal position. Bank of Japan to step up
asset purchases as growth and inflation fall back later in 2014.
US leading Japan and Europe (excluding UK). De-synchronised cycle implies divergence in monetary
policy with the Fed eventually tightening ahead of ECB and BoJ, resulting in a firmer USD.
Tighter US monetary policy weighs on emerging economies. Region to benefit from advanced country
cyclical upswing, but China growth downshifting as past tailwinds (strong external demand, weak USD
and falling global rates) go into reverse and the authorities seek to deleverage the economy.
Deflationary for world economy, especially commodity producers (e.g. Latin America).






Risks

Risks are still skewed towards deflation, but are more balanced than in the past. Principal downside
risks are Eurozone deflation and escalation of Russia-Ukraine crisis. Some danger of inflation if
capacity proves tighter than expected, whilst upside growth risk is a return of animal spirits and a G7
boom (see page 21 for more details).
Chart: World GDP forecast
Contributions to World GDP growth (y/y)
6
5.0
4.9
4.9
5.1
3.7
4
3.4
2.9
3
Forecast
4.6
4.5
5
2.5
2.6
2.3
2.6
2.6
2.8
2
1
0
-1
-1.2
-2
-3
00
01
US
02
03
Europe
04
05
Japan
06
07
08
Rest of advanced
09
10
BRICS
11
12
13
Rest of emerging
14
15
World
Source: Thomson Datastream, Schroders 27 August 2014 forecast. Previous forecast from May 2014. Please note the
forecast warning at the back of the document.
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Schroders Baseline Forecast
Real GDP
y/y%
World
Advanced*
US
Eurozone
Germany
UK
Japan
Total Emerging**
BRICs
China
Wt (%)
100
63.0
24.8
18.8
5.4
3.7
7.2
37.0
22.8
13.6
2013
2.6
1.3
2.2
-0.4
0.5
1.7
1.5
4.7
5.7
7.7
2014
2.6
1.6
2.0
0.8
1.6
3.0
0.8
4.2
5.1
7.3
Prev.
(2.8)
(1.9)
(2.6)
(1.0)
(2.2)
(2.9)
(1.2)
(4.2)
(5.1)
 (7.1)
Consensus 2015
Prev.
2.7
2.8  (2.9)
1.8
2.0  (2.1)
2.1
2.6  (2.9)
1.0
1.2  (1.4)
1.9
2.0  (2.3)
3.1
2.5  (2.4)
1.5
0.9  (1.0)
4.3
4.1  (4.3)
5.2
4.9  (5.1)
7.4
6.8
(6.8)
Consensus
3.2
2.3
3.1
1.5
2.0
2.6
1.2
4.7
5.4
7.2
Wt (%)
100
63.0
24.8
18.8
5.4
3.7
7.2
37.0
22.8
13.6
2013
2.7
1.3
1.5
1.3
1.6
2.6
0.4
4.9
4.6
2.6
2014
3.1
1.5
1.7
0.7
1.1
1.6
2.7
5.9
4.4
2.3
Prev.
(3.0)
(1.5)
(1.8)
(0.9)
(1.3)
(1.9)
(2.0)
(5.7)
(4.4)
(2.7)
Consensus 2015
Prev.
3.2
3.3  (3.1)
1.6
1.7  (1.6)
1.9
2.2  (1.9)
0.6
1.1  (1.2)
1.1
1.8  (2.0)
1.7
2.2
(2.2)
2.7
1.5  (1.6)
5.8
5.9  (5.6)
4.3
4.4
(4.4)
2.4
3.0  (3.1)
Consensus
3.1
1.7
2.1
1.1
1.7
2.0
1.8
5.6
4.2
2.9
Current
0.25
0.50
0.15
0.10
6.00
2013
0.25
0.50
0.25
0.10
6.00
2014
Prev.
0.25
(0.25)
0.50
(0.50)
0.15  (0.10)
0.10
(0.10)
6.00
(6.00)
Current
4368
375
258
20.00
2013
4033
375
224
20.00
2014
4443
375
295
20.00 
Current
1.67
1.34
102.4
0.80
6.15
2013
1.61
1.34
100.0
0.83
6.10
2014
Prev.
1.68
(1.68)
1.32  (1.35)
105.0
(105)
0.79  (0.80)
6.12  (6.18)
Y/Y(%)
4.3
-1.5
5.0
-5.6
0.3
2015
Prev.
1.63
(1.63)
1.27  (1.30)
110.0
(110)
0.78  (0.80)
6.05  (6.10)
Y/Y(%)
-3.0
-3.8
4.8
-0.8
-1.1
102.0
109.0
107.1  (108)
-1.7
105.5  (104)
-1.5







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
0.25
0.69
0.18
0.19
-
2015
Prev.
1.50  (0.75)
1.50  (1.00)
0.15  (0.10)
0.10
(0.10)
6.00
(6.00)
Market
0.91
1.46
0.20
0.19
-
Other monetary policy
(Over year or by Dec)
US QE ($Bn)
UK QE (£Bn)
JP QE (¥Tn)
China RRR (%)
Prev.
(4443)
(375)
(295)
19.50
2015
4443
375
383
20.00 
Prev.
(4443)
(375)
(383)
19.50
Key variables
FX
USD/GBP
USD/EUR
JPY/USD
GBP/EUR
RMB/USD
Commodities
Brent Crude
Source: Schroders, Thomson Datastream, Consensus Economics, August 2014
Consensus inflation numbers for Emerging Markets is for end of period, and is not directly comparable.
Market data as at 15/08/2014
Previous forecast refers to May 2014
* Advanced m arkets: Australia, Canada, Denmark, Euro area, Israel, Japan, New Zealand, Singapore, Sw eden, Sw itzerland,
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.
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Schroders Forecast Scenarios
Global vs. 2015 baseline
Scenario
Summary
Macro impact
Baseline
We have trimmed our global growth forecasts for 2014 and 2015 by 0.2% to 2.6% and 0.1%
to 2.8% respectively. This compares with an outcome of 2.6% in 2013 and paints a picture of
a sluggish world economy when compared to the cycles of the 1990s or 2000s. The
downgrade to 2014 largely reflects a weak H1, although there have been minor downgrades to
H2 in the US and Eurozone. For 2015, our forecasts have been trimmed in both the
advanced and emerging economes. In the former, this reflects the ongoing headwind from
debt deleveraging in both the consumer and public sectors and weak productivity growth on
the supply side. This impacts the EM economies who also face inflation and rebalancing
pressures such that growth remains sub-trend. The China forecast for 2014 has been raised
to 7.3% to reflect the effect of stimulus packages, but remains 6.8% in 2015.
Despite trimming the growth forecast, the global inflation forecast is little changed with a mix of
upgrades and downgrades. For the US we expect the Fed to end QE by October and raise
interest rates from June 2015 as unemployment continues to fall and wages accelerate. Our
inflation forecast is marginally higher and the Fed funds rate is expected to rise to 1.5% by end
2015. In the Eurozone we expect the ECB to monitor the impact of recently announced
measures to reduce bank funding costs, but no QE (soverign debt buying) as the economy is
expected to escape deflation. For the UK, we expect the first rate hike in February 2015 as a
result of stronger activity. In Japan we have pushed out an acceleration in QQE until October
when the BoJ is expected to downgrade growth expectations. China is expected to leave the
RRR unchanged, but pursue other means of stimulating activity in selected sectors.
Weak economic activity weighs on Eurozone prices with the region slipping into deflation.
Households and companies lower their inflation expectations and start to delay spending with
the expectation that prices will fall further. The rise in savings rates deepens the downturn in
demand and prices, thus reinforcing the fall in inflation expectations. Falling nominal GDP
makes debt reduction more difficult, further depressing activity.
Deflationary: weaker growth and lower inflation persists throughout the scenario. As a
significant part of the world economy, Eurozone weakness drags on activity elsewhere, while
some of the deflationary impact is imported by trade partners. ECB reacts by undertaking QE,
but the policy response is too small and too slow to avert the outcome.
DM growth picks up more rapidly than in the base as the corporate sector increases capex
and consumers spend more rapidly in response to the recovery in house prices. Banks
increase lending, reducing their excess reserves and asset prices boom. The Fed begins to
withdraw stimulus: rapidly tapering bond purchases in 2014. Interest rates rise and the Fed
begins to contract its balance sheet in 2015. However, the withdrawal of stimulus is not
sufficient to prevent a more rapid tightening of the labour market and a pick-up in inflation.
Reflationary: stronger growth and inflation vs. baseline. Stronger US demand supports activity
around the world. Commodity prices and US Treasury yields rise and USD strengthens as
inflation picks up and Fed unwinds QE and raises rates.
3. Productivity
recovers
Weak productivity has been a feature of the recovery in the US and UK and growth has been
largely driven by increasing employment. In this scenario the slowdown in productivity
gradually reverses as firms deploy technology to better effect resulting in improved output/
hour.
Better growth/ lower inflation. Increased productivity reduces unit wage costs thus keeping
inflation in check as economic activity recovers. The Fed are still expected to tighten policy,
but the lack of inflationary pressure means they can delay until later in 2015.
4. Capacity limits
bite
Central banks overestimate the amount of spare capacity in the economy believing there is
significant slack in the labour market and a substantial output gap. However, weaker trend
growth and the permanent loss of some capacity in the post financial crisis environment
mean that the world economy is closer to the inflationary threshold than realised.
Consequently, as demand increases, inflation starts to accelerate prompting a re-appraisal of
monetary policy and higher interest rates.
Stagflationary: tighter monetary policy slows growth, but inflation continues to rise until the
economy has returned to trend. Monetary policy tightens earlier in this scenario.
An implosion in the wealth management products area results in a major cut in Total Social
Financing depriving Chinese industry of funds. The resulting downturn in capex spending and
the adverse impact on consumer confidence results in a sharp slowdown in Chinese growth.
1. Eurozone
deflation
2. G7 boom
5. China hard
landing
Inflation
65%
-
-
6%
-0.8%
-0.9%
5%
+1.2%
+1.1%
2%
+0.4%
-0.3%
5%
-0.4%
+0.6%
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.
4%
-1.1%
-1.0%
Russia cuts gas and oil supplies to Europe.
Stagflationary. Europe is hit by the disruption to energy supply resulting in a fall in output as
alternative sources are put in place. Higher oil prices hit global inflation and the breakdown of
relations between Russia and the west creates significant volatility in financial markets.
6%
-0.5%
+0.2%
Capital expenditure fails to revive as businesses remain cautious on the outlook believing real
returns are below the cost of capital, whilst income becomes increasingly concentrated in the
hands of the rich with low propensity to consume.
Deflationary: weaker growth and lower inflation as demand remains sluggish. Softer commodity
prices also weigh on inflation. Fed still expected to end QE as scheduled but does not raise
rates during the forecast period. The opposite of the G7 boom scenario.
5%
-0.4%
-0.4%
2%
-
-
6. Russian rumble Russia invades East Ukraine. The west retaliates by significantly increasing sanctions and
7. Secular
stagnation
Probability* Growth
8. Other
*Scenario probabilities are based on mutually exclusive scenarios. Please note the forecast warning at the back of the document.
21
Issued in August 2014 Schroder Investment Management Limited.
31 Gresham Street, London EC2V 7QA. Registered No. 1893220 England.
Authorised and regulated by the Financial Conduct Authority
28 August 2014
I. 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
2014
2015
%
%
8
8
7
7
EM Asia
EM Asia
6
6
EM
5
5
EM
4
4
Pac ex JP
Pac ex JP
3
3
US
2
UK
US
2
UK
1
Japan
Eurozone
Japan
1
Eurozone
0
0
Jan
Mar
May
Jul
Sep
Nov
Jan
Mar
May
Jan
Jul
Feb
Mar
Apr
May
Jun
Jul
Aug
Month of forecast
Month of forecast
Chart B: Inflation consensus forecasts
2014
2015
%
%
6
7
EM
EM
6
5
5
4
EM Asia
3
Pac ex JP
EM Asia
4
Pac ex JP
3
Japan
2
US
UK
US
2
Japan
UK
1
Eurozone
1
Eurozone
0
0
Jan
Mar
May
Jul
Sep
Nov
Jan
Mar
May
Jul
Month of forecast
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Month of forecast
Source: Consensus Economics (August 2014), 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 custom ers 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
Issued in August 2014 Schroder Investment Management Limited.
31 Gresham Street, London EC2V 7QA. Registered No. 1893220 England.
Authorised and regulated by the Financial Conduct Authority