The report notes Fitch remains pessimistic on the economic outlook for the major advanced economies despite the fact that GDP growth has held up better than expected so far this year. The agency's GDP growth forecasts for 2009 have been revised downwards while inflation, unemployment and interest rate projections have been revised upwards since the last GEO report in April.
A 40% rise in oil prices since the April GEO is having the combined effect of reducing real incomes in oil-consuming advanced economies and limiting the scope for monetary policy easing to offset the impact of market-driven credit tightening on economic activity. At USD140 per barrel it is becoming clear that high oil prices - for a long time a factor that the world economy seemed to be able to shrug off - are having a palpable negative effect on demand prospects, not least through their impact on consumer confidence.
The US economy looks to have avoided recession in H108 but Fitch still sees this as a likely prospect in 2008. The substantial negative forces weighing on consumer spending have become more pronounced in the last three months and, with the labour market weak, Fitch expects consumer retrenchment to take over from the housing market as the main drag on growth in the next 18 months. Fiscal policy easing and relatively robust exports - reflecting emerging market demand and the weaker dollar - will mean the downturn is less severe than the early 1990s but Fitch is expecting sub-trend growth to be prolonged into 2010.
The euro area has shown more resilience as the German economy has continued to surprise on the upside with an ongoing domestic investment expansion and strong export demand from emerging markets. But headwinds are blowing strongly elsewhere in the currency bloc, with both Spain and Italy having slowed sharply and the French economy starting to exhibit all the signs of a housing- and consumer-led slowdown. The French economy holds the balance to broader euro area prospects.
Inflation has re-surfaced and is currently running at 16-year highs in both the euro area and the UK and is likely to breach similar territory in the US in coming months as it heads above 5%. Central banks are becoming increasingly vocal about the risk of 'second-round' effects from high headline rates becoming embedded in ongoing inflationary pressures.
The European Central Bank has most to be concerned about as euro area growth prospects have been less adversely affected by tighter credit conditions and wage inflation has clearly been rising. But the forthcoming broader slowdown in the context of improved supply-side potential in Germany means the ECB will remain on hold after the latest 25bps increase. The Fed has also become increasingly vocal about inflation of late but the likely recession will squeeze core inflation, meaning the Fed is unlikely to start raising rates until early next year.
