The story of 2004 for the global economy was one of a slowdown after a bright start. Annual growth peaked in the first half, but then dropped away as gains proved disappointing in a number of countries. Looking forward, there is scope for a moderate re-acceleration this year, but 2006 is likely to be a year of fairly subdued growth, with economic activity gradually slowing in response to higher interest rates.There are clear indications that there will be measured rises in global interest rates this year. The Federal Reserve is likely to keep pushing up rates towards a more neutral level against the background of reasonably firm economic growth and concerns about the possible upside risks to inflation. In Europe, the European Central Bank is on hold for now, but it too will in time seek to reduce the degree of monetary stimulus. The weighted average level of rates for the Group of Seven industrialised countries is likely to rise by another 40 basis points over the next six months and by 80bp over the next year, even if Japan persists with zero rates over those time horizons. Contrasting slightly with this global view on interest rates is our view on Britain. Consumer price inflation here is forecast to move up to the 2% target over the next six months. However, this does not necessarily rule out a cut in interest rates by the end of this year, as we see consumer spending and housing market activity decelerating throughout 2005 and into 2006. Our forecast pattern for global growth is slightly out of kilter with the consensus view, which sees a slightly weaker picture this year but less of a continuing slowdown in 2006. There are several reasons for optimism that growth will pick up a little after the period of disappointment in the latter part of 2004. Financial conditions remain stimulative in the global economy, with government bond yields low, corporate bond spreads tight and equity markets buoyant. Corporate finances are generally in good shape. Companies have been cautious in their capital spending and hiring policies, but there remains scope across the globe for continued expansion. Industrial production is starting to pick up again. In America output has moved ahead in recent months, and latest figures for Britain, France and Germany all firmed in December after earlier weakness. The headwind from energy prices is fading. Oil prices are currently at about last autumn’s peak, but the relative stability in recent months has softened concern that high energy prices may inhibit decision-making. Although the supply/demand balance remains tight, demand growth is slowing and Saudi Arabia is aiming to boost its supply capacity on the view that oil prices are going to remain significantly higher than generally expected a few years ago. Increased energy-related investment, including infrastructure such as ships, pipelines and refineries, is likely to be a feature of the next few years. Turning to America, the economy is now in a phase of slightly above-trend growth, with GDP forecast to rise by 3.6% this year. Growth is now being led by corporate spending rather than consumer spending fuelled by tax cuts and low interest rates. However, a significant acceleration is unlikely against a backdrop of residual corporate caution, stretched household finances and rising interest rates. Indeed, we retain the view that the economy will slow to a moderately below-trend pace of 3% in 2006. Part of the story is an expected slowing of consumer spending from the unexpectedly strong pace recorded in the second half of last year. That strength relied on a further drop in the savings ratio from an already very low level, as households continued to use the housing market as a source of funds to finance current spending. This trick will be much harder to achieve in future if higher interest rates curb house prices and turnover in the housing market. We remain relatively optimistic on the outlook for the dollar despite the likelihood that any improvement in the US current account balance will be small. The weakness in the dollar in the fourth quarter of last year has pushed the currency down to the extent that American assets are starting to look cheap to overseas buyers. In addition, tax changes are encouraging a repatriation of funds by American companies. It is true that sentiment remains fragile and can be unsettled by reports that some central banks may diversify their currency holdings. But, in our view, further depreciation of the dollar should occur against Asian currencies, rather than the euro and sterling.