Special Year-End Issue: Looking to 2007: Global Economics Team, Morgan Stanley

Our baseline forecast points to a sustained global expansion through 2008. After expanding at a 4.8% average pace over the 2003-06 period — the strongest four years of global growth since the early 1970s — we are forecasting a modest downshift to 4.3% in 2007. Such an outcome would be well above the 45-year growth trend of 3.7%, suggestive of a global economy that is coming in for a classic soft landing. Our first cut for 2008 calls for a fractional re-acceleration to 4.5% global growth.

The global downshift in 2007 should be broad-based. The US and Europe are expected to lead the deceleration in the developed world, and a slowing of Asia ex Japan stands out in the developing world. In the US, we expect a housing-related “growth recession” to persist through 1Q07, with important knock-on effects for export-led economies heavily dependent on US demand — especially China, Mexico, Canada, Japan, and other Asian economies tied to China’s supply chain. China’s progress in cooling off an overheated investment sector should provide another impetus to the coming global downshift.

The risks are on the downside of our 2007 global soft-landing scenario. As post-housing-bubble adjustments begin to play out in the US, the risks of spillovers to other sectors — especially personal consumption and business capital spending — are especially worrisome. Lacking in support from private consumption, the rest of an export-dependent world could be surprisingly vulnerable to a US growth shortfall. Pro-labor political shifts in the US, Germany, France, Italy, Spain, Japan, and possibly Australia could shift the pendulum of economic power from capital to labor — raising the risks of trade frictions and earnings pressures that could prove quite problematic for world financial markets.

This is the final issue of the Global Economic Forum for 2006. We will resume regular publication on Tuesday, January 2, 2007. Our very best wishes for the Holiday Season.

Morgan Stanley Global Economics Team

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