World economic growth will probably quicken to 3.9 percent this year from 2.7 percent last year but slow again in 2005 as US interest rate hikes bite and high oil prices may crimp activity, Fitch Ratings said on Wednesday.
In its autumn "Sovereign Review", the credit ratings agency said it had raised its estimate for this year's growth from the 3.6 percent it previously forecast.
"The star performer has been Japan, where growth is likely to reach 4.2 percent in 2004, but the UK and the euro area are also expanding raster than previously expected," it said.
Looking ahead, it forecast growth in world gross domestic product (GDP) would slip to 3.3 percent in 2005 and 3.0 percent in 2006. Consumer price pressures were likely to build and the US Fed funds rate could rise faster and higher than many market participants expected, thereby unsettling emerging markets, Fitch chief economist Lionel Price said.
Fitch said high oil prices may help slow global growth to a more sustainable rate but added that with US fiscal and monetary policy still stimulative, the risk is that growth may not slow sufficiently and inflationary pressures will build.
The firm expects oil prices to remain above US $30 a barrel over the next two years.
High oil prices do not have as great an impact on the global economy as they used to, Fitch said, but the scale of the recent increase to record highs "is now sufficient to reduce growth in the coming year by up to 1 percentage point below what it would otherwise have been."
The US Federal Reserve has raised interest rates twice since the end of June and its key rate is at 1.5 percent. Fitch said inflationary pressures could push the fed funds rate up to 4 percent by 2005.
Fitch estimates emerging market sovereign bond issuance will reach US $52 billion this year, the highest since 1997, and for the first time emerging Europe will surpass Latin America in government debt issuance.
Aggregate financing needs are expected to rise by just US $17 billion to US $268 billion in 2005 after rising US $43 billion in 2004.
SOME UNDERESTIMATE RISK: Fitch believes that some investors are too sanguine about inflation expectations and are resuming their carry trades, that is borrowing cash in low interest rate currencies such as dollars and investing in higher-yielding emerging sovereign debt.
"With emerging market spreads tight, Fitch remains concerned that high risk appetite is causing investors to underestimate emerging market risk, particularly among weaker credits, leaving the asset class vulnerable to a correction," the report said.
But even if there is a correction, Fitch believes the sector is better equipped to deal with turbulence as macroeconomic management has strengthened and contagion risk has been reduced by the broadening of the investor base.
With regards to Europe, Fitch said the Stability and Growth Pact was encouraging some budgetary restraint but the guideline that budget deficits should not exceed 3.0 percent of GDP continued to be breached.
"France and Germany did undertake to ensure their deficits would be below 3.0 percent by 2005, but their current budget proposals look far from certain to avoid a fourth year over 3.0 percent," Fitch said.
It said one-off measures aimed at keeping Italy's deficit below 3.0 percent until this year are no longer sufficient.
In July, rival ratings agency Standard & Poor's downgraded Italy's rating because of a deterioration in public finances.
Fitch said that its credit assessments of euro zone states focuses on the sustainability of their debt and that temporary swings in the annual deficits would have limited impact.
"But the longer their "excessive deficits" persist, the less flexibility these already highly indebted governments will have to meet future shocks," the ratings agency added.
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