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News : Global Economy Last Updated: Jan 7, 2015 - 10:40 AM

OECD says Eurozone risks stagnation if policy response too week
By Michael Hennigan, Finfacts founder and editor
Nov 25, 2014 - 2:33 PM

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The Organisation for Economic Co-operation and Development (OECD) said today that the Eurozone risks prolonged stagnation if the policy response is too weak and confidence remains low.

The think-tank for the governments of 34 mainly developed countries said growth has again disappointed and projections in today's Economic Outlook are weaker than in the May Economic Outlook. Global growth is expected to strengthen by 2016, but it will remain modest by past standards.

The Euro area and Japan are currently the two most worrying spots on the OECD map, with an expected pick-up in growth to 1.7 and 1%, respectively, in 2016. And this already assumes stronger policy support than is currently on the table. In the emerging world, China is experiencing a welcome slowdown to more sustainable growth rates of around 7%.

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Angel Gurria, OECD secretary-general said that the outlook is subject to important risks. First, there are major risks associated with financial volatility as US interest rates are raised in the course of next year.

Second, the rapid credit growth in China in recent years could lead to a bumpy landing of the economy. A simulation in the Economic Outlook shows that a 2 percentage point drop in the growth of Chinese domestic demand would reduce global GDP growth by ½ percentage point after 2 years, hitting hardest countries like Japan, India and Russia that are most closely linked to the Chinese economy.

Third, there is a risk of a prolonged period of stagnation in the euro area if the policy response is too weak and confidence remains low. A simulation in the Economic Outlook shows that a decline in inflation expectations by 50 basis points combined with a worsening of financial conditions for firms and households could lower Euro area GDP growth by around ½ percentage point in 2015 and around 1 percentage point in 2016, bringing the expansion close to a standstill.

The unemployment rate would rise by around ½ percentage point as a result.

Global GDP growth is projected to reach a 3.3% rate in 2014 before accelerating to 3.7% in 2015 and 3.9% in 2016, according to the Outlook. This pace is modest compared with the pre-crisis period and somewhat below the long-term average.

The euro area is projected to grow by 0.8% in 2014, before slight acceleration to a 1.1% rate in 2015 and a 1.7% rate in 2016.

“With the Eurozone outlook weak and vulnerable to further bad news, a stronger policy response is needed, particularly to boost demand,” said Catherine L Mann, OECD chief economist . “That will mean more action by the European Central Bank and more supportive fiscal policy, so that there is space for deeper structural reforms to take hold. A Europe that is doing poorly is bad news for everyone.”

Jean-Claude Juncker, European Commission president, on Wednesday will announce a new €315bn plan to boost Europe’s economy that will be built on €21bn in EU seed money including the European Investment Bank, coupled with most reliance on the private sector, according to EU officials.

Among the major advanced economies activity is gaining strength in the United States, which is projected to grow by 2.2% in 2014 and around 3% in 2015 and 2016. In Japan, growth was impacted by consumption tax hikes in 2014, with expected growth of only 0.4% in 2014, and rises modestly to 0.8% in 2015 and 1% in 2016.

Large emerging economies are projected to show diverging performance over the coming years. A slowdown in China, towards more sustainable growth rates, will see GDP growth drop from a 7.3% growth rate in 2014 to a 7.1% rate in 2015 and a 6.9% rate in 2016. However, the rapid increase in credit, rising share of non-bank credit as well as housing market and local government activity are raising concerns about financial stability. A scenario in the Outlook shows that a 2-percentage point decline in the growth of Chinese domestic demand would lower global GDP by 0.3 percent per year.

“The Chinese authorities will need to use all of their policy instruments to keep the economy on an even keel,” Ms Mann said.

Ireland is forecast to see GDP grow by 4.3% in 2015; 3.3% in 2015 and 3.2% in 3.2% while UK growth is forecast at 3% this year, 2.7% in 2015 and 2.5% in 2016.

“Growth has been propelled by high job creation and is set to continue at a strong pace in 2015 and 2016, underpinned by robust private consumption and investment. Private consumption has been the main engine of the expansion, amid strong job creation, and business investment continues to recover strongly, supported by diminishing uncertainty,” the OECD said on the UK. “GDP growth is set to continue at a strong, if slightly easing, pace, despite fiscal consolidation.”

It recommended that the Bank of England should raise interest rates from mid-2015.

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