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Global Economy Loses Strength as Oil Costs, Debt Woes Take Toll

Dominic Wilson
Goldman Sachs economists led by Dominic Wilson and Jan Hatzius said in a May 25 report they now expect “less upside in equities” with their colleagues reducing price targets for most of the major regions even though they still anticipate another 10 percent gain in developed markets this year. Photographer: Ramin Talaie/Bloomberg

The world economy is losing strength halfway through the year as high oil prices and fallout from Japan’s natural disaster and Europe’s debt woes take their toll.

Goldman Sachs Group Inc. now expects global economic growth of 4.3 percent in 2011, compared with its 4.8 percent estimate in mid-April, while UBS AG has cut its projection to 3.6 percent from 3.9 percent in January. Downside risks also include a shift to tighter monetary policy in emerging markets.

“The world economy has entered a softer patch with the incoming growth data mostly disappointing,” said Andrew Cates, an economist at UBS in Singapore. “We suspect this soft patch will endure for longer.”

Data this week backed that outlook as reports showed Chinese manufacturing expanding at the slowest pace in 10 months, orders for U.S. durable goods dropping the most since October and confidence among European executive and consumers sliding for the third straight month. Investors are tuning in, pushing the MSCI World Index of stocks in advanced economies down 4.2 percent this month.

Goldman Sachs economists led by Dominic Wilson and Jan Hatzius said in a May 25 report they now expect “less upside in equities” with their colleagues reducing price targets for most of the major regions even though they still anticipate another 10 percent gain in developed markets this year.

The concern comes as leaders from the Group of Eight conclude a summit in Deauville, France, with a statement that declared the world economy is “gaining strength” and that its recovery will pave the way to debt reduction. They identified commodity prices as a “significant headwind” to expansion.

The MSCI World Index rose 0.6 percent at 6:15 a.m. in New York today, paring its weekly lose, after the G-8 statement.

Energy Costs

Oil prices reached a 31-month high of $114.83 on May 2 as the war in Libya cut supply. Goldman Sachs this week raised its forecast for Brent crude at the end of 2012 to $140 a barrel from $120, suggesting the price’s path will be 20 percent higher than anticipated at the start of the year. That’s enough to shave 0.5 percentage point from U.S. growth over two years and a little less in other wealthy nations, they said.

The fallout from Japan’s earthquake, tsunami and nuclear disaster may also be reverberating, said David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York, who calculates the international expansion will duck beneath its long-term trend this quarter.

Japan’s Consumers

Japan’s retail sales fell 4.8 percent from a year earlier in April, the Trade Ministry said in a report released today, underscoring the impact on consumers from the March disasters and forecasts for gross domestic product to shrink for a third straight quarter in the three months to June.

While spillover to Asia’s emerging economies has been “surprisingly modest,” Hensley said supply-chain disruption is “likely to rise with time” as Japanese production and exports remain depressed before beginning to recover around September.

“The global economy is losing momentum,” Hensley said.

China, after powering the global economy out of the 2009 recession, may also be slowing. The world’s No. 2 economy has raised interest rates four times since mid-October and boosted banks’ reserve-requirement ratio eight times since November, most recently on May 12.

ING Groep NV this month cut its estimate for China’s full-year growth to 9.8 percent from 10.2 percent and reduced its second-quarter forecast to an annual pace of 9.6 percent, from 10.3 percent. Credit Suisse Group AG adjusted its 2011 expansion estimate to 8.8 percent from 9.1 percent. China’s stocks this week fell by the most in eleven months.

Central Banks

“Investors are worried that the tightening is overdone and concerns have widened to a slowdown in earnings and economic growth from just inflation,” said Wang Zheng, chief investment officer at Jingxi Investment Management Co. in Shanghai, which manages about $120 million.

Emerging-market central banks elsewhere are also throttling back. Those in India, the Philippines, Chile, Poland, Peru and Malaysia all raised their benchmark borrowing costs this month to cool price pressures.

Europe’s 18-month debt crisis is another brake on growth as its policy makers prepare a second aid package to save Greece from default and other so-called peripheral economies deploy austerity measures to slash debt. At the same time, the euro’s 6 percent gain against the dollar since the start of the year and the European Central Bank’s shift toward tighter monetary policy may be slowing expansion elsewhere in the region.

Impact on Companies

The global economy’s change in tone is reflected in some company announcements. Chicago-based Boeing Co., the world’s largest aerospace company, said it received two orders last month compared with 98 in March. Hermes International SCA, the Paris-based maker of Birkin handbags, said on May 11 that its forecast for 2011 is “clouded by geopolitical and economic uncertainties.”

The slower growth may still be short-lived and by cooling the oil price could even provide some support for consumers and inflation relief for central bankers, allowing them to keep monetary policy looser for longer. Other reasons for confidence include job growth in the U.S., expectations for an infrastructure-led bounce in Japan’s economy, supportive equity markets and a likely recovery in inventory accumulation, said Hensley at JPMorgan Chase.

Economists Nariman Behravesh and Sara Johnson of IHS Inc. said in a May 24 report that while they expect worldwide growth to slow to 3.5 percent this year from 4.1 percent in 2010, it will rebound to 4 percent in each of the next two years as the pain of austerity, Japan’s woes and high oil prices passes.

“Assuming these shocks do not get any worse and that the world economy is not hit by additional unforeseen jolts, chances are good that the period of slow growth will be relatively short and that the recovery will pick up steam again,” they said.

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