Heather Stewart and Larry Elliott (The Observer) – Will the coming year be one of tax cuts, pay rises and good cheer, or will the legacy of the financial crisis still haunt us? And what of China, Japan, the eurozone … Observer writers try to predict the economic shape of the next 12 months
Will rising house prices and higher pay bring back the feel-good factor?
As the Bank of England’s chief economist, Spencer Dale, pointed out recently, Britain’s microwave-like housing market tends to “turn from lukewarm to scalding hot in a matter of a few economic seconds” – and that seems to be exactly what’s happened over the past 12 months. By the end of 2013, the London market was well on the way to scorching and, in almost every other part of the country, it had at least begun to defrost.
Brits – at least those who have managed to clamber on to the housing ladder – love nothing better than rising property prices, and the recovery has been a key driver of growing consumer confidence and spending. But for those locked out of the housing market, the key to a happier new year will be whether, and when, real wages finally start to recover from the longest squeeze in more than a century.
With overseas demand weak, a large pool of jobless workers and an extraordinary 3 million people saying they are “underemployed” and would prefer to work more hours, it’s hard to see what would make employers start paying more. For the time being, we’re likely to be left relying on a good old-fashioned, debt-fuelled boom.
Will Mark Carney raise interest rates in 2014, as the economy gathers pace?
He certainly hopes not. The whole thrust of the Bank of England’s policy since the Canadian central banker took up the reins in Threadneedle Street has been to reassure consumers and companies that the Bank won’t “pull the rug out” from under the recovery by raising rates too soon.
Of course, the definition of “too soon” is up for grabs. The monetary policy committee opted for an unemployment rate threshold of 7% when it announced its policy of forward guidance, assuming at the time that it would be at least three years before that was reached. Just three months later, they conceded we could get there within a year and a half.
But the Bank has enthusiastically embraced the new macroprudential tools that it hopes will allow it to smooth out booms and busts in certain markets – such as property – without clobbering the economy with an across-the-board rate rise. Its director for financial stability, Andy Haldane, has called this a “sharp philosophical shift”. So even if unemployment drops below 7%, it seems unlikely the Bank will reach for a rate rise without yanking other levers first – and that’s likely to take us into 2015 at the earliest.
Is the global economy heading for another crash?
Not much has been seen of Gordon Brown since he left Downing Street in May 2010, but the former prime minister caused a stir earlier this month when he said failure to learn the lessons of the 2007-09 financial and economic crisis means the global economy is heading for another meltdown.
Brown speaks from experience and has a point. The unity displayed when the world was looking into the economic abyss after the collapse of Lehman Brothers did not last long. Many problems, including too-big-to-fail banks and the growth of a largely unregulated shadow banking system, have not been adequately addressed. Central banks are unclear about how and when to remove the colossal stimulus they have provided for their economies over the past five years.
These core weaknesses mean it would be unwise to rule out another financial crisis in 2014. Crashes did, after all, have a habit of breaking out every few years before the Big One in 2007. Nor should it be any comfort that no one can see one coming in 2014. That’s what they said last time.
How will Janet Yellen fare as Federal Reserve chairman?
Ben Bernanke will bow out in the new year, having already set in train the process of tapering the Fed’s vast programme of quantitative easing. Bernanke said he expected it to take until the end of 2014 to shut the money presses down altogether, but it will be helpful to Yellen, who has often been seen as dovish, that the symbolic first step towards weaning the financial markets off super-cheap money has already been taken. Better still, world markets responded enthusiastically.
But it may not all be plain sailing: just because investors shrugged off the first step doesn’t mean there won’t be a more severe response as tapering continues. And the make-up of the Fed’s open markets committee, which sets interest rates, is due to take on a more hawkish tone as QE sceptics Richard Fisher (of Dallas) and Charles Plosser (of Philadelphia) take up voting seats. If inflationary pressure rises as the economy picks up, Yellen will face growing calls to move faster. As a serious economist and Fed veteran, she has as good a chance as anyone of walking the fine line between scuppering recovery and letting inflation run out of control. But unwinding QE on this scale is an unprecedented challenge: it seems all but certain that more turmoil lies ahead.
Which of the emerging markets looks risky in 2014?
If there is to be a seismic shock to the global economy next year, the smart (sic) money is on it coming from the emerging world. Developing countries have seen large flows of “hot money” courtesy of the QE activities of the west’s central banks. With interest rates low in the developed world, investors have parked their cash in the higher-yielding currencies of the emerging economies. Now that the Federal Reserve has started to reduce the amount of stimulus it is providing each month, the fear is that the hot money will leave emerging markets as quickly as it arrived, leaving countries facing runs on their currencies.
The most vulnerable emerging markets look to be those with big current-account deficits, because they are likely to be the first targets for currency speculators. High on the list would be Brazil, South Africa, Turkey and India.
The biggest risk of all, however, is China. Foreign investors have been impressed by the economic reforms announced by the communist leadership but, in the short term, China is slowing down after its debt-fuelled recovery from the last recession. A hard landing in China would have severe global ramifications.
Is the eurozone over the worst of its tribulations?
Yes, to the extent that a disorderly breakup of the single currency has become far less of a risk since Mario Draghi said in July 2012 that the European Central Bank would do “whatever it takes” to safeguard the euro’s future. But no, if the criterion is the state of the eurozone economy. Four big legacy problems from the last crisis will hold Europe back over the coming 12 months: growth, unemployment, deflation and zombie banks.
Unlike the US and, latterly, the UK, the eurozone has yet to recover from the recession of 2008-09. A double-dip recession ended in 2013 but growth is still barely positive and not nearly strong enough to bring down a joblessness rate of more than 12%. Deflation is already a reality in Greece and Cyprus, while in Portugal, inflation is only just above zero. Falling prices increase the real value of debt, making it harder for countries to repay what they owe. The two potential flashpoints for 2014 are the ECB’s asset quality review of Europe’s banks, and the need for fresh bailouts for the two most vulnerable countries: Greece and Portugal.
What’s more likely: tax cuts in the budget or the sack for Ed Balls?
Rumours have been swirling around Westminster since the autumn statement that Ed Miliband is losing patience with his shadow chancellor and is thinking of replacing Balls in a reshuffle. But it looks improbable, and not just because the Labour leader lacks a credible alternative. Balls was right when he warned austerity would hold back the recovery; to throw him overboard now would give the impression that George Osborne was right all along.
There is far more chance the chancellor will provide a bit of a budget giveaway. After all, the public finances are improving and, by March, the general election will be little more than a year away. But Osborne is in no position to throw money around: the public finances are in much worse shape than he expected them to be when he took office in 2010, and the priority is to balance the books by the end of the decade. Any tax cuts will be small, and largely financed by savings elsewhere. If there is to be a giveaway, it will be in the 2014 autumn statement or the 2015 budget.
Will Abenomics succeed in fixing Japanese economy?
The drastic attempt by Japanese prime minister Shinzo Abe, to jolt the moribund economy into life has already borne fruit: since he took power a year ago, growth has picked up to a cracking annual rate of 3%, and deflation of -0.1% year on year in December 2012 had given way to inflation of 1.1% by October.
But the burning question for 2014 is whether the first two of his three policy “arrows” – a spending surge and quantitative easing on a massive scale – will be followed by the promised third arrow: economic reform. Among other things, the Abe administration is creating hundreds of thousands of childcare places, in a bid to tempt more mothers into the workplace and harness the power of what he calls womenomics. A series of overseas trade deals, including the ambitious Trans-Pacific Partnership, are also likely to lead to the opening-up of new sectors of Japanese industry to competition.
But these are long-term reforms, and investors are expecting Abenomics to go on yielding quick results. There’s a clear risk markets will lose faith with the debt-burdened Japanese government in the meantime (ratio of debt to GDP: 246%). By the end of 2014, we will have a much clearer idea of whether Abe’s gamble has paid off.