The slowdown in the global recovery promises a prolonged period of ultra-low interest rates as central banks in the developed world rethink their strategies and react to a series of shocks to their economies.
The U.S. Federal Reserve has already taken the rare step of suggesting rates could remain at their emergency lows for another two years, triggering dissent within its ranks. Others among the world's central banks are, like the Fed, grappling with how to react to fears of another slump, which is sure to keep their rates low as well and prompt more emergency measures.
Concerns about the health of the global economy will be highlighted again this week when second-quarter GDP figures are reported by Japan and the European Union, which are expected to add to a growing list of countries posting weak growth in the first half of the year. Already, the U.S. and France have registered limited or stalled second-quarter growth.
Japan’s GDP is expected to decline again, as the country’s economy struggles to regain its footing following the March earthquake and tsunami, and overall GDP for Europe will show only slight growth over the previous quarter, economists suggest. France, which reported its GDP figures last week, stalled out with no growth in the second quarter.
“I think that the economic numbers we are going to get are going to show the economy was more fragile heading into the second half of the year,” said Craig Alexander, senior vice-president and chief economist at Toronto-Dominion Bank. “Market sentiment is that Q3 will be even weaker.”
At the same time, inflation is expected to slow down in most industrialized countries, though some emerging markets, including China and India, are likely to see inflation remain at very high levels.
The latest reading of the U.S. economy pegged GDP growth at an annualized pace of 1.3 per cent in the second quarter, though that number could still be revised when final figures are reported later this month. Last month, the U.S. revised its first-quarter GDP growth down to 0.4 per cent from a previous reading of 1.9 per cent.
News of a slowing global economy, coupled with three weeks of turbulence in global markets, will likely prompt some central banks in the developed world to hold off on raising interest rates.
“You generally don’t want to raise interest rates when the economy’s not doing great,” said Benjamin Tal, deputy chief economist at CIBC World Markets.
High rates make it less attractive for businesses and individuals to borrow, spend money and hire new workers, creating a further drag on the economy. And with commodity prices retreating and the economic recovery slowing down, inflation is expected to be less of a threat for industrialized countries going into the second half of the year.
Japan, the U.S. and Switzerland already have interest rates that are close to zero, so their options for stimulating growth are limited. “The problem now is that interest rates are so low that you can’t lower them any more,” Mr. Tal said.
He noted that emerging markets have the opposite problem. Annual inflation in China rose to 6.5 per cent in July and consumer prices in India are also soaring. “The dividing line is the emerging markets. They have inflation. The rest, generally will be dealing with deflation,” he said.
The European Central Bank has raised interest rates twice this year, moves many economists say were premature given continued instability in the world’s economic recovery.
Britain reports second-quarter inflation on Tuesday, followed by the EU on Wednesday, the U.S. on Thursday, and Canada on Friday, and economists predict the consumer price increases could be set to stabilize or fall in the second half of the year. “It looks like inflation has crested in major industrial economies,” said Douglas Porter, deputy chief economist at BMO Nesbitt Burns. “I suspect that will be the theme across the industrialized world.”
One exception could be Britain, where the price of a basic basket of goods in England rose 4.2 per cent between June, 2010, and June, 2011, well above the Bank of England’s target rate of 2 per cent. High inflation and a weakening economy in that country are squeezing household finances, Bank of England Governor Mervyn A. King said last week.