EconSouth (Fourth Quarter 2005)

Global Economic Expansion Rolls On Into 2006

The global economy is forecast to grow steadily in 2006, driven mainly by the United States and China. Latin American economies should sustain their momentum while the euro area is likely to improve on its subpar 2005 performance. High energy prices will remain the greatest threat to the positive global outlook. Forecasts for 2006 project economic growth outside the United States to be about 3.4 percent, similar to 2005’s estimated 3.3 percent growth.

Energy prices remain high and volatile
The price per barrel of West Texas Intermediate crude oil, a global benchmark price, was approximately $60 at the end of October, a rise of 42 percent since the end of 2004 (see the chart). In an effort to keep inflation in check, several foreign central banks, including the Bank of Canada and the European Central Bank, have begun to tighten monetary policy.

West Texas Intermediate
Crude Oil Prices, 2004–05
Source: Wall Street Journal and Haver Analytics

According to the International Monetary Fund’s (IMF) World Economic Outlook, average consumer prices in developed countries (excluding the United States) are forecast to rise only 2 percent in 2006, down from 2.2 percent in 2005 (see the table). In developing countries, inflation should average about 4.5 percent in 2006, down from 5 percent in 2005.

Demand for exports boosts Western Hemisphere
In Canada, strong growth continues to be driven primarily by robust domestic consumption and strong demand for the country’s exports. The outlook for 2006 is upbeat, with the IMF projecting 3.2 percent growth, higher than the 2.9 percent estimated in 2005.

Latin America continues to benefit from strong commodity prices, especially for oil and metals. In many Latin American countries, increased export revenues have generated trade surpluses, which, along with conservative fiscal policies, have reduced the public debt burden. For example, both Colombia and Mexico have serviced their external debt through the end of 2006.

With this solid base, the economic outlook is positive for much of Latin America. But the possibility that commodity prices could decline sharply adds some downside risk to the outlook. In addition, the 17 presidential and legislative elections slated for next year, the most since 1994, could cause economic volatility. The IMF projects the region’s real economic growth to be 3.8 percent in 2006, only 0.3 percentage points lower than in 2005.

Strong export demand is driving economic growth throughout the Western Hemisphere. Exports are one of the catalysts behind the 3.2 percent growth that the International Monetary Fund predicts for Canada in 2006.

Outside Japan, Asia continues to boom
China has become an increasingly important player in the global economy, especially in Asia. Strong demand for its exports continues to support China’s economy. The IMF estimates Chinese economic growth reached 9 percent in 2005 and forecasts 8.2 percent growth in 2006.

The main challenge for China will be maintaining strong growth while balancing domestic consumption with export growth and gradually adopting a more flexible currency exchange rate. In July 2005, the People’s Bank of China, the central bank, announced its first step toward a more flexible exchange rate policy by revaluing the renminbi by 2.1 percent against the U.S. dollar. Using a basket of currencies to manage the exchange rate, the bank has allowed the renminbi to fluctuate against the U.S. dollar within a band of plus or minus 0.3 percent.

Elsewhere in developing Asia, economic growth remains strong, propelled by a recent acceleration in exports. But high oil prices could dampen global demand and cloud the region’s prospects for the coming year. Many countries in the region are eliminating or reducing government oil subsidies, which have proved to be too expensive. Exports to China continue to drive the region’s growth. Forecasts for 2006 predict real gross domestic product growth of around 5.7 percent for developing countries in Asia excluding China.

Gross Domestic Product and Consumer Price Index Projections by Region
Annual percent change
Real GDP
Canada 2.9 3.2 2.2 2.5
Latin America 4.1 3.8 6.3 5.4
China 9.0 8.2 3.0 3.8
Developing Asia less China 5.4 5.7 7.4 6.4
Japan 2.0 2.0 –0.4 –0.1
Euro area 1.2 1.8 2.1 1.8
Source: IMF World Economic Outlook, September 2005

In contrast, the Japanese economy continues to lag. The IMF forecasts only 2 percent growth for Japan in 2006, the same as in 2005. On the bright side, household consumption appears to be strengthening, and fears of continued deflation are easing. Japanese inflation is likely to be close to zero in 2006.

Euro area looks at modest growth
In the euro area, economic activity remains sluggish, but prospects for growth are improving, and export demand will continue to drive growth for the region. However, high energy costs have increased inflationary pressures somewhat. September’s 2.6 percent inflation rate and October’s 2.5 percent rate fanned concerns at the European Central Bank (ECB) that inflation might stay above its target rate of 2 percent.

In response, in early December the ECB raised its interest rate target by 25 basis points to 2.25 percent, its first policy move since the middle of 2003. As a result, the IMF expects inflation in the euro area to fall to 2.1 percent by the end of 2005 and forecasts an inflation rate of 1.8 percent for the coming year. The IMF projects overall growth in the area for 2006 at around 1.8 percent, an improvement on the estimated 1.2 percent growth in 2005.

This article was written by Elena Whisler, an economic analyst in the regional section of the Atlanta Fed’s research department. The international estimates and forecasts represent a consensus of private-sector or multilateral outlooks and are not those of the Federal Reserve Bank of Atlanta or the Federal Reserve System.

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