May 31, 2012

Eurozone Trapped in "One Currency Fits None" and "One Policy Rate Fits None" Scenario According to BNY Mellon's Hoey


Recent Drop in Energy Prices Should Support Real Income Growth

LONDON and NEW YORK, May 31, 2012 — Expecting that the euro will survive in some form, BNY Mellon Chief Economist Richard B. Hoey expects that a full-scale European financial meltdown will be avoided according to his May 2012 Economic Update.  Hoey is pessimistic, though, about economic activity in the peripheral and soft core countries of Europe over the next several years.

Hoey expects that Europe is likely to eventually agree to slow the pace of fiscal austerity, while further easing actions from the ECB are likely.  "The U.S., U.K., Japan and many other countries borrow in their own currencies, for which they control supply," Hoey says.  "However, each country in the Eurozone has been borrowing in a foreign currency that it cannot create, the euro."  

"In 2012, we continue to expect worldwide economic growth of about 3%, somewhat slower than the IMF's April 2012 forecast of 3.5%," Hoey states in the report.  "We expect a global growth recession, with an economic decline in Southern Europe, slight declines or slight growth for several quarters in the U.K. and much of Northern Europe, near-trend growth in the U.S. and sustained but slower growth in China and other emerging market countries."

Hoey also offers several perspectives on the interpretation of the recent sharp drop in commodity prices in this report including: (1) spot commodity prices are a traditional short-term leading indicator of economic activity; (2) commodities were a focus of financial speculation on the theme of a "commodity super cycle" due to the expected increase in demand from an emerging market boom; (3) commodity prices are priced on the "full probability distribution of multiple scenarios, including unlikely but plausible 'tail risks'" and (4) the recent drop in energy prices should support real income growth.

While Hoey believes that the U.S. will continue on its current growth path for the balance of the year, he concludes that the most likely case is a turbulent battle over taxation, spending and the debt ceiling in a post-election lame-duck session of Congress, eventually resolved by a fiscal tightening of 1% to 1.5% of GDP for 2013 in the U.S., "much smaller in size than the 'fiscal cliff' of about 4% of GDP embodied in the current law and widely feared."

Finally,  Hoey states, "Volatility in prices can occur due to changing estimates of tail risks, even when there is little or no change in the consensus about the most likely case."

See http://www.bnymellon.com/foresight/update-video.html for Hoey's complete May 2012 Economic Update. 

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