GLOBAL ECONOMY-Taper tantrum conceals brightening growth picture

Sun Jun 23, 2013 2:00pm EDT

Related Topics

* Economies in Europe, Britain over the worst

* U.S. set to do better once fiscal drag fades

* Asia resilient in face of capital outflows

By Alan Wheatley, Global Economic Correspondent

LONDON, June 23 (Reuters) - Markets dismayed by the Federal Reserve's stimulus withdrawal timetable might be in no mood for good news, but evidence is mounting that other rich economies are joining the United States on the road to recovery.

Improving growth prospects, of course, are the main reason why the Fed expects to phase out its bond purchases, now running at $85 billion a month, by the middle of 2014. The U.S. central bank reckons output will expand by 3.25 percent next year.

The euro zone, too, seems to be stabilising after 18 months of recession as fiscal headwinds blow a little less fiercely, while economists are upgrading their growth forecasts for Britain as household incomes improve.

Japan has already discovered a new lease on life thanks to aggressive monetary and fiscal stimulus.

"There are pretty clear signs of an improvement in developed-world final domestic demand," said Daniel McCormack, a strategist with Macquarie in London.

He said Europe was clearly over the worst, with even heavily indebted countries on the rim of the euro zone, such as Spain, finding a floor.

The modestly brighter outlook will be reflected in euro zone business and consumer sentiment figures on Thursday, according to economists polled by Reuters. Germany's IFO business climate index, due on Monday, is also expected to have edged higher.

FED WIPES AWAY THE FROTH

In the United States, new and pending home sales are likely to confirm the upswing in housing that is keeping the economy on a moderate expansion track despite a combination of tax rises and spending cuts this year equal to about 1.8 percent of GDP.

Larry Kantor, global head of research for Barclays based in New York, said this fiscal drag would limit growth to an annual pace of 1.5 percent this quarter and 2.0 percent next quarter.

But no further fiscal tightening is programmed for 2014, a year when interest rates will still be at zero, the housing recovery will still be under way and consumers will be enjoying the lagged wealth effect of higher share and house prices.

"If we don't get, in 2014, significantly better growth in the U.S. we're never going to get it," Kantor said at a news briefing in London. "You've got all these forces aligned for stronger growth next year."

The violent sell-off in bonds and shares since last Wednesday's Federal Open Market Committee meeting shows the market had not expected Bernanke to set forth such an explicit calendar for phasing out the Fed's asset purchases.

The volatility was unlikely to abate right away and Fed officials were nervous about how the 'tapering' process would unfold, according to Kantor, a former Fed staffer himself.

But he said Bernanke was right to re-inject two-way risk into asset markets, whose powerful, sustained rally had threatened a replay of recent boom-and-bust cycles in dotcom shares and housing.

"The Fed wants to take some froth out of the markets and, given the experience we've had with asset prices, this is actually healthy," Kantor said. "A lot of FOMC members had seen this movie before."

Emerging markets have borne the brunt of the sell-off as investors dump higher-yielding bonds and shares bought with cheap borrowed dollars.

But Rob Subbaraman, chief economist for Asia ex-Japan for Nomura in Hong Kong, said he was not downgrading his forecasts despite the exodus of capital. Except for China, growth was likely to accelerate across Asia in the second half of 2013.

Despite the Chinese slowdown, Asian export prospects looked brighter as global demand was poised to improve and central banks had let their trade-weighted exchange rates weaken, Subbaraman said. What's more, lower commodity prices and loose policy settings were supporting domestic demand.

"So Asian growth will hold up pretty well. When the dust settles and people realise that the Fed isn't about to aggressively tighten policy, I think capital will come back to Asia," Subbaraman said.

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