Global economy continues recovery despite bumpy road ahead(2)

DIVERGENT POLICIES POSE RISKS

In addition to possible stagnation risks in Japan and the euro area, a key economic uncertainty next year is diverging monetary policies of the advanced economies.

While the Fed is expected to raise interest rates some time in 2015, the euro zone and Japan will continue loose monetary policies to support weak demand.

Investors are keeping a close eye on the future paths of U.S. inflation and European economic growth, said the Standard & Poor's. The path of U.S. consumer price inflation will dictate the timing and degree of the Fed's interest hike, while the risk of recession in Europe could jeopardize the U.S. economic recovery and also influence the Fed.

As the United States is tightening its monetary policy, Moody's said, a broad-based asset price correction could occur, triggering a steep and far-reaching increase in financial market volatility, raising financing costs across markets, restrain capital inflows in emerging markets and in turn dampen economic growth.

William Dudley, vice chairman of the Fed, said the U.S. central bank will be cautious in the pace of monetary policy tightening, which will depend not only on the economic outlook but also on how financial market conditions respond as the Fed begins to remove monetary policy accommodation.

Fed Chair Janet Yellen said in December's press conference that the Fed considered it unlikely to begin the normalization process for at least the next couple of policy meetings. The central bank's next scheduled policy meeting is on Jan. 27-28. The following is March 17-18.

LOWER OIL PRICES TO BOOST GLOBAL GROWTH

Deflation has been a potential threat to the world economy, and the recent sharp decline in oil prices might weigh down the headline inflation in some countries. But unlike previous scenarios in which falling oil prices reflected withering demand and weighed heavily on growth prospect, most economists and regulators believe lower oil prices will support demand of net oil importers and give a boost to global growth.

The IMF expects the recent appreciable fall in oil prices, if sustained, will boost growth. Yellen said it will have only transitory downward pressure on U.S. inflation, and will boost household demand just like tax cuts. The Bank of Japan also downplays any concerns of potential threat on its pledge to foster 2 percent inflation, instead welcoming the resulting boost to growth.

David Stockton, a senior fellow at the PIIE and former head of the Fed's economic research division, said low inflation is indeed a concern for major economies in the world. But he does not believe there will be deflation risk next year, as positive boost from the lower oil prices will gradually lift the price level but at a much lower pace.

According to Moody's, moderate growth in oil demand coupled with steady increase in supply will keep oil prices broadly stable around recent lower levels next year. The lower oil prices will benefit most Group of 20 economies, which tend to be net oil importers, but have a negative impact on growth in net oil exporting countries such as Russia and, to a lesser extent, Mexico.

In addition, geopolitical risk is widely seen to remain a challenge to the world economy next year. But S&P believes the impact of most current geopolitical flashpoints is likely to be regionally contained, and will only in the rarest of circumstances spill over into the global scene to have an impact on far-flung economies.