Euro debt is greatest concern for global economy

The Eurozone debt crisis is the biggest problem for the global economy, followed by the possible effect of a Middle East conflict on oil supplies and the continuing slowdown in China, according to Invesco chief economist John Greenwood.

Greenwood said that the next test for the Eurozone is whether euro-area banks can meet the 9% tier one capital requirement by the end of June. He said banks are converting debt to equity and retaining earnings. One result from this is lower lending, meaning that there is little help to the real economy from banks which could prolong recession in Europe and promote the existence of a two-speed Europe with growth in the North, and austerity in Southern Europe as governments attempt to cut deficits. “The best hope for the Eurozone as a whole is that the ECB’s easy money policy stance through LTROs [longterm refinancing operations] continues, fuelling a strong recovery in Germany and other core economies. This would have favourable spillover effects on the struggling peripheral economies, encouraging southern Eurozone exporters and raising relative prices in the core,” Greenwood said.

Looking elsewhere, Greenwood said that the US economy has moved towards self-sustaining growth in the past six months with improvements in income, household spending and in employment. But in the UK and continental Europe, governments have little scope to back spending programmes given that government expenditure is already close to 50% of total GDP. On China, Greenwood said that the economy has avoided a hard landing, but it is clearly still slowing. Policymakers are forecasting only 7.5% real GDP growth in 2012 and local financial market sentiment has been adversely affected, he added.

In terms of investments, Greenwood said that central bank policy rates in the developed world will remain close to zero for an extended period, meaning investors will continue to search for yield, commenting: “I expect this will in turn cause quality assets that generate safe and sustainable yields to be bid to a premium relative to assets generating lower income streams. Examples of such ‘quality assets’ would include corporate and certain higher-yielding bonds in the fixed income area, equities with high dividends that are insulated by steady earnings growth or solid dividend cover against subpar economic performance, or real estate funds that can assure strong and stable flows of rental income.” On commodities, he said that both agricultural and industrial commodities remain vulnerable to slowdowns in Europe and Asia.