The global economy

30 June 2008

The global economy has slowed since the second half of 2007 against the backdrop of the financial turmoil and a deepening US downturn. At the same time, global inflation has risen, led by rapid increases in prices of energy and key food items. The current consensus view is still that the global economy will slow only modestly further in 2008. Developments up to the first quarter have been broadly consistent with this view as growth in the euro area, Japan and major emerging market economies continued to be strong.

Unfolding developments at the core of the global financial system have, however, also created great uncertainty about future economic prospects. Banks in several advanced industrial economies have been tightening lending standards, and thus a generalised squeeze in the availability of credit remains a distinct possibility, with potentially more severe implications for demand than are reflected in consensus forecasts. These developments have been compounded by the recent rapid rise in oil prices and increased inflation expectations in a number of major economies.

The extent to which households with overstretched balance sheets in the United States and some other advanced industrial economies will have to retrench in the face of these negative shocks is hard to predict. While a substantial rise in US household saving could bring about a further sizeable reduction in the US current account deficit, it would do so at the price of weakening demand in the rest of the world. At the same time, inflation risks are greater than they have been for many years.