Economics Weekly - 2008 was a year of shock and awe for the world economy; Weekly economic data preview - Fed and weak data put pressure on central banks to slash rates
Economics Weekly 22 December 2008
*The next Economics Weekly is published on 12
January 2009. We wish all our readers a Happy Christmas and a prosperous New
2008 was a year of shock and awe for the world economy
2008 has been a year
full of tumultuous events for financial markets, with the failure of some of
the brightest names in the banking sector and wholesale government rescues
being mounted for most of the rest. Low financial market volatility, a feature
of the last seven years, turned into one of the highest periods of volatility ever experienced
in some markets. The boom in the world economy has come to an abrupt end and now
seems a distant memory. But at the start of the year, there was some optimism
that while economic growth would slow,
outright recession would be avoided. Now, the world economy faces the worst recession
since the 1980s. Inflation was not seen as a major problem at the start of
2008, but by the end of the year deflation and disinflation were the main
Economic forecasts for 2008 were almost uniformly
show that expectations for economic growth in 2008, made in December 2007, were
way too optimistic. Chart a illustrates that the latest (December 2008)
projection for growth this year has turned out to be sharply lower for every
country included. Such was the growth momentum at the start of 2008, however,
that although all of the countries in the chart are now in recession, none of
them will see an outright fall in gdp this year; that will come in 2009, when
all of them will see a fall in output. For the UK, economic growth is on
course to turn out less than half what was the expected increase. For Japan, economic growth will
turn out to be two-thirds less than predicted at the start of the year.
â€¦economic growth, inflation, interest rates
were all thrown off courseâ€¦
This deterioration in
the growth performance is occurring despite lower short term and long term
interest rates in all of the major economies than was expected at the start of
2008. Charts c and d highlight how much interest rates, short and long term,
have collapsed. But short term rates are measured using interbank quotes, and these are
much higher than official benchmark lending rates due, of course, to the
ongoing credit crisis. If short term rates are analysed in terms of official
levels, they are in most cases at or below historic lows, because these
economies were at the epicentre of the credit crisis, except Japan whose banking sector
has not been as badly hit by it directly.
Despite weaker economic
growth, consumer price inflation has turned out higher than forecast, see chart
b. Indeed, consumer price inflation has been higher in all of the economies
projected than was expected, as economic growth in the first half of 2008
turned into outright declines in output in the second half. This is testament
to the ferocity of the turnaround that has occurred in the global economy in
2008 ending, in the case of the UK, 16 years of
uninterrupted growth and one of the longest and strongest expansions in the
world economy since the Second World War. Oil and commodity prices played a
decisive role in pushing up inflation, so reducing real incomes and hence
hitting economic growth. For instance, oil prices rose to a peak of $147 a
barrel in July before subsiding to around $35 at present. As a result, the economic
forecasting record was not great last year for anyone, but then the demise of
famous companies that had survived for hundreds of years and the effective
failure of the global financial system does not occur too often either.
â€¦because of one of the worst ever financial
The year started with
fears that the credit market crisis, which had begun in Q3 2007, could spill
over into price deflation and economic crisis. However, chart e shows that
credit market and stock market risk perceptions, as measured by the Vix
volatility index, were stable, albeit at a much higher level than in the
previous 5-7 year period. But in the second half of the year with the
bankruptcy of Lehman Brothers (a 150 year old firm), the rescue of all of the
top US investment banks and a host of other financial market companies, as
Fannie Mae and Freddy Mac also went into explicit public ownership, confidence
went into a nosedive. This is shown in charts f and g, where stock markets
crashed lower and the dollar fell sharply against some currencies but gained
against most others. However looked at, 2008 was as fundamentally a defining
moment in economic and financial markets history as any in previous
generations, and it is not yet over as we enter 2009. Many of the issues and
challenges posed in 2008 are persisting into 2009 - with some sort of
resolution possible for some of them, one way or another - but not necessarily
for all of them.
Weekly economic data
preview W/c 22 December 2008
Fed and weak data put
pressure on central banks to slash rates
The historic decision
by the US Fed to cut interest rates to a range of zero to 0.25 percent and the commitment
to keep them at exceptionally low levels for some time has raised pressure on
other leading central banks to follow suit and further reduce interest rates.
Following the Fed's move last week, the BoJ cut rates to just 0.1%, the
Norwegian central bank slashed them 1.75% to 3% and the Danish central bank by
an unexpected 0.5% to 3.75%. Recent data also suggest the economic slowdown is
intensifying, while the threat of deflation continues to mount. We expect the
BoE and ECB to cut interest rates by up to 1% in January, to potentially 1% and
1.5%, respectively. As the room for further cuts diminishes, we also expect
more unconventional measures, such as 'quantitative easing' -directly boosting
money supply, to target ongoing strains in credit markets. As expected, the
calendar is relatively light over the main holiday period for key data, however
the risk of important policy announcements is still quite high. Thin volumes
and 'year-end' also raise the potential for volatility. The week starting 5 Jan
should see trading volumes and general market activity pick up sharply, helping
to underpin prices.
â€¢ In the UK, we expect
confirmation this week that the economy shrank by 0.5% in the third quarter of
2008, while the first view of the balance of payments data is forecast to show
the current account deficit narrowed to Â£10.6bn in Q3, from Â£11bn in the second
quarter. While the gdp data may be revised slightly, the recent disappointing
PMI indices for manufacturing, services and construction suggest the economy
may have contracted by over 1% in the final quarter for the first time since the
start of the last recession in 1990. The risk of an excessive fall in the
exchange rate led the BoE MPC to decide against cutting Bank rate by more than
1% earlier this month, however another sharp reduction in January may be
unavoidable, taking official interest rates to the lowest on record. Despite
the sharp fall in sterling over the past year, the UK's goods trade deficit
has stayed close to Â£8bn, mainly reflecting slowing external demand. However,
the current account deficit in the first half of the year was over Â£10bn
smaller than in H1 2007, primarily reflecting a sharply higher income surplus. Nevertheless,
the deficit still represented 3% of gdp in Q2 and the risk is that it widened
in the third quarter, which could put further downward pressure on sterling.
Next week, there are some key data published on Friday. The November lending to
individuals figures are forecast to show housing market activity remained
constrained and modest growth in consumer credit. The manufacturing PMI may
have fallen further in December, from a survey low of 34.4 last month. The BoE
decision, on Thursday, provides the highlight in the first full week of 2009,
with the services PMI and manufacturing data on either side of it likely to
show falling output. Producer prices data, on Friday, may show further sharp
falls in December.
â€¢ The focus in the US in the weeks ahead
will remain on credit market developments, with discussions still ongoing with the
major auto companies over the final terms of the bailout and the Fed adding to
its rapidly expanding balance sheet. Data are likely to show further signs of
economic weakness, with this week's personal income and spending numbers for
November watched particularly closely for indications of how sharp the overall
gdp contraction may be in the final quarter. Ahead of these figures, other data
should confirm the economy shrank by 0.5% in Q3 and again underline the fragile
state of the housing market. Next week, the consumer confidence and ISM
manufacturing indices are likely to show weak outturns in December, with both
potentially falling below last month's readings as general conditions have deteriorated.
The December labour market report is due on 9 January. Weekly jobless claims
data suggest another fall in the region of 500,000 in non-farm payrolls is
likely, while the unemployment rate is forecast to edge up closer to 7%.
â€¢ Recent data from the
euro zone show the economic slowdown is intensifying and has added further pressure
on the ECB to lower interest rates. The next regular monthly meeting is on 15
January. Data in the coming weeks will confirm the growing impact of the credit
crisis on the real economy, while also highlighting the ebbing threat of
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