A combination of factors, including the downward pressure on budget deficits in Europe being exerted by the need to meet the criteria for European monetary union, together with the misalignment of key exchange rates, is causing downward pressure on global demand.
Some private sector forecasters believe that this downward pressure - unless it is offset by aggressive interest rate reductions - will at best lead to a severe slowdown but could potentially tip Europe into recession this year. However, official forecasters at the OECD dispute this, believing that easier monetary policy following interest rate cuts which already have taken place, should safely return the global economy to robust growth by the second half of this year.
Putting aside the concerted effort to reduce fiscal deficits, the key to the performance of the world economy in 1996 will be the trend in inflation, which in turn will influence interest rates and currency trends. There is a growing consensus among economists that the inflation threat - the main concern for the past two decades - is in retreat.
Oil prices, which have been a key ingredient of inflation, will remain under downward pressure. After an upward blip in 1995, when the average oil import price for the main western economies reached $17.4 per barrel, the OECD forecasts it will slip back to $16.7 a barrel in 1996, in keeping with lower demand.
This in turn will ease the cost pressures on commerce, including the airline industry. The private sector forecaster Paribas Capital Markets forecasts that inflation in the US, Germany, Japan, France, the UK and the Netherlands will be well below 3 per cent in 1996 with prices also on the decline in more inflation-prone European countries. The OECD reckons inflation across its members will average at least 1.8 per cent this year.
The lack of price pressures should enable many of the larger industrial economies to ease monetary policy in 1996 - essential to keep recovery on track. The process of lowering interest rates began at the end of last year when the Bundesbank acted to bring down its money costs, as did the UK authorities and the Federal Reserve in the US.
Lower interest rates are being predicted in almost every major economy (with the exception of Japan where they cannot go any lower) including emerging markets like Mexico.
There is some expectation - and exchange rates are one of the most difficult indicators to predict - that normality will return to the currency markets in 1996 now that inflation is becoming less of a factor. The Japanese yen already has fallen 25 per cent from the peak reached in April against the US dollar.
But senior economists at the IMF still believe that there is a serious misalignment among the major trading currencies. The dollar remains undervalued against both the German mark and the yen. In the case of the mark, low inflation could lead to an outflow from 'safe haven' currencies, to those considered less stable like the dollar. The yen should continue to weaken in 1996 as capital flows out of Japan into the US and Europe which offer better interest rate returns.
So how will the trend towards lower interest rates and a more competitive mark and yen affect the major economic regions of North America, Europe and Japan? Last year the US economy slowed sharply following the robust 4.1 per cent growth of 1994. The likelihood is that the US will continue to expand in 1996 but at a slower rate. Interest rate cuts should keep the economy moving with an expected expansion of 2.3 per cent, which will not be enough to make much impression on an unemployment rate of some 5.6 per cent. The strengthening dollar may exert downward pressure on demand, while the main US risk could be the end of the consumer boom cycle.
Germany starts 1996 in relatively poor shape. Its export sector, the main engine of German growth, will be hit by the double whammy of the delayed impact of the strong mark and weaker activity in Germany's main export markets, including France.
It is forecast that growth across the EU, which accounts for 58 per cent of German exports, will slow in 1996 as a result of the budget stringency. This will have a stronger influence on German growth than the double digit expansion of its exports to the Pacific region. Private sector forecasters believe that German growth could be held to just 1.5 per cent in 1996, although the OECD is a little more optimistic with a projection of 2.6 per cent growth.
The most disappointing economic region is Japan, where growth has been barely positive following over-valuation of the yen and fierce competition from its dynamic neighbours.
The devaluation of the yen in 1995 will begin to make a positive impact this year with industrial output already showing signs of increased activity. Moreover, the impact of easier fiscal policy together with the lowest interest rates anywhere in the free world is starting to stimulate domestic demand.
The OECD is predicting that GDP growth will improve from a marginal 0.3 per cent last year to 2 per cent in 1996 and 2.7 per cent in 1997. Growth will not be as dynamic as in the past because of sluggish export markets in the US and Europe, which have been through their growth surge.
Overall, 1996 should be a steady year for the main western economies, providing a stable economic background for the larger airlines to consolidate their profitability. But with western growth fragile, the economic system will be vulnerable to shocks such as banking collapses or a fiercer downturn than expected in Europe as it struggles to conform to Maastricht.
Alex Brummer
Source: Airline Business
