As the effects of the U.S.-led slowdown continue to reverberate around the world, Scotia Economics has lowered its global economic forecast.

In a research note published Thursday, Scotia says that it now expect global economic activity to contract by an average of 2.2% in 2009, a call that represents a downward revision of 0.6 percentage points from a month ago. “For the most part, we are continuing to revise down our forecasts for economic activity in the developed world outside of the United States, reflecting the cascading effect of the U.S.-led downturn and credit contagion on trade and capital flows,” it said.

The forecast for Euro zone output has been lowered by 1.5 percentage points to an average decline of 4% for this year. Japan’s real GDP prediction has been shaved by roughly half a percentage point to a contraction of 4.5% for 2009. “These regional counterweights have been increasingly hard hit by the double-barrelled collapse in trade between developed and developing regions around the world,” it said.

The same forces will impact Canada too, and it now sees output dropping 2.6% this year, a 0.2 percentage point revision.

“Our forecast suggests that the largest contraction in output in many of the world’s economic drivers, like the United States, and in the case of China and India, the smallest gain during their slowdowns, occurred in the first quarter of 2009. Looking ahead, the rate of decline in economic activity is expected to moderate throughout the developed world in the current quarter, and pick up speed in some of the larger, developing world economies,” it says. “Much of this deceleration is being fuelled by market forces — lower energy prices, heavily discounted prices for goods, reduced inventory liquidation, and in some cases, renewed currency weakness — in conjunction with aggressive policy easing.”

It notes that this expected shift carries risks, as the global economy has yet to fully escape the grip of recession. “Further retrenchment in the motor vehicle sector lies ahead. Across the business spectrum, firms are consolidating against the backdrop of the unrelenting squeeze on earnings, resulting in continuing pressure on employment, business investment, and real estate. Households are expected to remain a weak link in the outlook, with hefty declines in incomes and wealth resulting in more saving and less spending,” it says. “Moreover, the tourniquet on credit has yet to be completely unwound, with the latest proposals to help stabilize U.S. financial institutions still to be implemented.”

“Regenerating growth in the second half of the year critically depends upon the thrust provided by unprecedented monetary and fiscal stimulus,” it adds. Scotia expects the Bank of Canada to cut its overnight rate once more on April 21 by 25 bps to 0.25%, with the potential of a shift to a Fed-style target range of 0-0.25%, and then moving to the sidelines until late 2010. The Federal Reserve is also expected to leave its target range at 0-25 bps until late 2010.

IE