Reports of the European Forecasting Network (EFN)

In the autumn of 2012, economic growth in the world is rather anemic; production in most regions has been weak for some time: the recovery in the US began to slow down early this year; production has been shrinking in the euro area and in Britain since the autumn 2011; and the temporary rebound of production in Japan appears to have ended this summer. Already in 2011, economic expansion in emerging markets, and in China in particular, began slowing down markedly. World trade has all but stagnated in the first half of 2012.

In 2012 and 2013 we expect world production to grow modestly, since external conditions have deteriorated as growth dynamics appear to be declining in important emerging economies. However, the euro area crisis remains the central risk factor for the world economy. Euro area GDP is expected to decline 0.2 percent in 2012 when compared to 2011; for 2013 we expect fiscal policy to be a bit less restrictive and private investment to increase, with GDP expanding by 0.9%. The unemployment rate will remain well above 11%.

In the first months of 2012 there were some mild signs of improvement in the world economy, to a large degree due to political measures taken in the euro area at the end of 2011. In particular, the ECB secured financing of banks by offering liquidity for as longs as three years and by easing standards for collateral. However, the southern countries of the euro area will stay in recession for most of the year 2012: planned fiscal consolidation in Spain and Italy has a magnitude of about 3% relative to GDP, in Portugal and Greece the restriction is even larger. The structural reforms need time to take beneficial effects, and the real sector is largely out of reach of the expansive monetary policy.

At the end of 2011, prospects for the world are clouded. The main cause for concern is that the euro area crisis of confidence has not reached its peak yet. It is doubtful whether Italian and Spanish debt service would be sustainable if yields stay at these levels for long. Even more critical are the financing conditions for European banks whose standing crucially depends on the valuation of the sovereign bonds they own. This uncertainty will continue inducing firms and households to postpone decisions on spending and investment, and fiscal policy will dampen demand further. Besides, financial conditions are also bound to deteriorate in most member countries. Moreover, weak demand from advanced economies is dampening the expansion in exportoriented emerging markets countries (in East-Asia, but also in Latin America). As a consequence, both our forecasts for the euro area exports and industrial production have been revised downwards.

High growth dynamics and demand coming from emerging markets will slow only modestly in the rest of 2011 and in 2012, but the intensification of the financial turmoil and the doubts about the ability of the European Union to contain the consequences of possible defaults will hamper world economic growth considerably in our forecasting horizon. For the euro area, we expect GDP to grow by around 1.6% in 2011 and 0.8% in 2012, not enough to bring the unemployment rate back below 10% and substantially less for 2012 than in our Summer report. Many private households and firms will adopt a wait-and-see attitude while, to restore confidence in the euro area sovereign debt, fiscal policy will become even more restrictive.