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Global economy on a roll, but inflation lurks

Unemployment is falling and central banks need to remain on guard as inflation risks mount due to increases in the cost of food, commodities and shipping, the Paris-based OECD said in a twice-yearly report on international economic prospects.

“The current economic situation is in many ways better than what we have experienced in years,” chief economic Jean-Philippe Cotis said.

Interest rate policy needed to remain tightish.

Inflation apart, a big danger was that governments would splurge soaring tax revenues for short-term gain rather than use the good times to cut debts and deficits, repeating what Cotis called the catastrophic errors of the late 1980s and late 90s.

The OECD raised previous forecasts for growth this year and next in Europe and Japan and lowered them for the United States but said it believed the US slowdown, caused by a slump in the housing market, would not sink the world’s largest economy.

US down but not out

It dropped its 2007 growth forecast for the United States to 2.1 percent from 2.4 percent previously but predicted a recovery to growth of 2.5 percent in 2008, after 3.3 percent in 2006.

It raised its Japanese growth forecast for this year to 2.4 from 2.0, followed by growth of 2.0 percent next year, after 2.2 percent in 2006.

The OECD highlighted Europe’s German-led recovery and also a surprise rebound in Italy, raising its forecasts for the 13-nation euro currency area as a whole to 2.7 percent this year followed by a more moderate 2.3 percent in 2008.

China, the world’s fourth largest economy, was headed for another runaway year of growth topping 10 percent and “may have exceeded the speed limit”, said the OECD. It recommended Beijing let its currency rise to tame inflation and a huge trade surplus.

Cotis said in an interview with Reuters that Beijing should loosen the state’s control over exchange rates for its own good but that the currency, which Washington and Europe believes is unfairly and artifically low, would remain weak as long as the Chinese people kept stashing so much money away in savings.

The OECD predicted growth of 2.7 percent this year and next for the 30 mostly industrialised countries in the organisation, which this month invited Russia to join along with Chile, but not China.

Unemployment was set to fall, it said, to 5.5 percent for the OECD as a whole from 5.6 percent in 2006, and most notably in Europe, to 6.7 percent from 7.1 in 2006 and 7.8 in 2005.

Overheating?

The OECD said there was even some risk of overheating and urged central banks to keep the screws fairly tight on rates.

“On the monetary front, there is a risk that, in many places, the balance between aggregate demand and supply has already started shifting towards overheating, at a time when the appetite for fiscal tightening may be waning,” Cotis said.

The danger was not coming from wage demands, the OECD said.

It advised the US Federal Reserve to keep key policy rates where they are in 2007, contrary to the belief among some in the financial markets that the central bank may start cutting soon to shore up the economy.

The OECD said it expected the European Central Bank to raise its key interest rate twice more this year, to 4.25 percent. The OECD saw those rises coming in June and late 2007 followed by a pause in 2008, Cotis said in the interview with Reuters.

Britain should keep rates on hold too and if anything there was a risk it might need to raise them, an OECD official added.

Japan’s problem was the opposite one, a nagging danger of deflation despite a long period of improving economic growth, said Cotis. Salaries were not rising as might be expected and the country had yet to nail the coffin on deflation.

“It’s very troubling,” he said.

Bubble bubble...

Mindful of a dot.com bubble in technology stocks which ended in tears at the start of the decade, the OECD said the price of shares and other assets appeared a little overdone again, but Cotis said there was nothing overly alarming about it.

“We’re a long, long, long way from there,” Cotis said. “This is not a crisis situation.”

Cotis highlighted that while the economy was “rebalancing” nicely in the sense that Europe and Japan were doing more for growth as the US lost steam, there was little sign of any meaningful reduction in current account imbalances.

Recent stabilisation in the US deficit looked like little more than a temporary phenomenon and the shortfall was likely to swell again once the economy picked up, he said, adding that surpluses in China and Japan were still rising.

“There’s no progress there,” he said.