General

There have been no changes to our economic growth forecasts since last month’s report. Focusing on developed nations (the average of the US, UK, Continental Europe and Japan), we forecast a slowing of growth from 2.4% in 2007 to 1.3% this year (previously 1.7%), followed by a modest acceleration to 1.6% in 2009 (previously 2%). For the world including developing nations, we see growth slowing from 4.8% in 2007 to 3.8% and 3.7% in 2008 and 2009 respectively. In other words, our forecasts paint a picture of a drawn out period of subdued growth rather than a quick recovery. As a result of these changes, risks are more evenly balanced, although still somewhat skewed to the downside. Our forecast for developed nations’ growth is now broadly in line with the consensus. Our 2008 global inflation forecast remains unchanged at 2.8% this year but should fall back to 1.6% in 2009.

United States

We believe that a US recession is now well under way. First quarter GDP growth was weak as it rose by only 0.6%, quarter-on-quarter. The April job report was better than expected with the unemployment rate down from 5.2% to 5.0%, and the change in the non-farm payroll was lower by 20K versus 75K expected. However, house prices and home sales continue to fall. The US Federal Reserve has been providing financial agents with huge liquidity for several months now and has lowered interest rates aggressively. Low business confidence, tighter lending standards and high volatility in the markets increase lack of confidence when forecasting investments. The US consumer has been hit hard by weakness in the housing market and there is a risk that capital spending will also be impacted.

United Kingdom

The economic backdrop in the UK continues to be weak; GDP growth may, if current indicators carry through, grind to a halt in the coming months as tighter credit conditions bite on the housing market, consumer spending and corporate spending. However, the negative effects on growth will eventually ease, as lower interest rates take some of the pressure off household spending. Major threats for the United Kingdom stock market include the weakening housing market which is impacting domestic demand, its high exposure to commodities and inflation pressures which are limiting the Bank of England’s scope to reduce rates aggressively. Inflation is expected to be at or above 3% in the second half of this year as another major round of gas, electricity and fuel prices hit home.

Continental Europe

The euro zone economy is decelerating. The German IFO (business confidence survey) indicator, though still high, has now turned south. Advance indicators are softening from their peak. Looking ahead, household propensity to consume is expected to decline with banks tightening credit conditions to both corporate and individuals. Furthermore, the strength of the euro in trade-weighted terms is weighing on productivity gains as it increases the price of European exported goods. The labour market, which has been a strong support for domestic demand, will be key to avoiding any material deterioration of economic activity in the euro zone. The inflation estimate for April declined from 3.6% to 3.3%, year-on-year.

Japan

We continue to believe that Japan’s economic performance will depend on exports while domestic consumption should remain weak. The economy grew by 0.8% quarter-on-quarter in the January – March period, more strongly than the market forecast at 0.6%. External demand contributed 0.5% of this. Whilst there was a slowdown in exports to the US, demand for Japanese products in Asia and other emerging economies remained strong. On the domestic front, there is a clear sign that vicious cost-push inflation is developing. The Yen’s sharp rise will be a risk factor. Small and medium enterprise earnings are being squeezed by higher raw material costs. Earnings are firm at some large companies, but this will not be enough to lift the economy overall.

Pacific

Developed Asian markets remain in negative territory year to date, but April saw a sharp rebound in performance, with Australia and Hong Kong both up over 8%. Australia's central bank left rates unchanged after last month’s hike and they remain at 7.25%. Inflation is the real issue, with the latest report at a 16-year high and unemployment at a 34-year low. Hong Kong cut interest rates by 75bp to 3.75%, following the US Federal Reserve's move (the local currency HK$ is pegged to the US Dollar). While Hong Kong’s retail sales rose less than anticipated, Singapore's latest retail sales and industrial production figures rose strongly. We remain reasonably positive on the outlook for the region and believe it will continue to benefit from strong growth in China, despite the forecast recession in the US during 2008.

Bonds

Our government bond yield forecasts continue to point to higher yields in 12 months time. In the US, we think ten-year Treasuries will trade at 4.5% from 4.05% at the time of writing. In the UK, Eurozone and Japan we also forecast rising yields, although to a more limited extent. The UK 10-year gilt yield is expected to rise to 5.15%, the 10-year German bund yield to 4.3% and finally the 10-year Japanese government bond to 2.1%. Although there is little long-term value in longer-dated government bond markets, yields are likely to remain volatile within a trading range in the short run. Nevertheless, a sustained rise in yields is expected towards the end of 2008. The recent rise in yields means we are starting to see some value in selective bonds, notably sterling. However, we are still of the opinion that bonds remain over priced and we remain underweight although to a lesser degree than previously across all strategies.

Currencies

It was yet another very volatile period for currencies with the Euro setting new all time highs against both Sterling and the US dollar but it has weakened since. We continue to expect the US dollar and the Japanese yen to be the strongest of the major currencies over the next 12 months as relative interest rate differentials surprise in their favour. As expected on April 30 the Federal Reserve cut rates by another 25 basis points to 2%. The view on future movements is again now clouded by inflation which may rise to 4.5% in the coming months which may prompt the Fed to raise rates by year-end but no further cuts are forecast at present. In the UK, with inflation rising it may be that the current expectation of rate cuts is delayed somewhat, although some commentators expect a rate cut in June following the sharp fall in house prices recently. The ECB continues to talk tough on inflation, but weaker economic data should provide the catalyst for a first interest rate cut in the summer.