Economics Weekly - Real economy still not seeing money flow freely; Weekly economic data preview - Markets to be tested by heavy week of US data & bond issuance
Economics Weekly - 27 July 2009
Real economy still not seeing money flow freely
Despite unprecedented injections of
liquidity, monetary growth is still slowing
Since the global
financial crisis erupted, central banks around the world have pumped billions
into stabilising financial markets. To a large extent this has worked, in terms
of currency volatility, money market interest rate spreads, equity and bond markets,
there has been a marked improvement. Indeed, the evidence is that investment
banks have been restored to health, if burgeoning profits in Q1 and Q2 for
those involved in financial market instrument and activity (i.e., advising
commercial companies on issuing debt and equity finance, betting on spreads and
yields etc) are anything to go by.
There remains evidence
that those financial institutions that are less involved in money market activities,
in other words facing off to the real economy - in terms of consumer debt
finance, credit cards, mortgages and company finance - are not doing so well.
Part of the reason appears to be that money is simply not flowing to these
areas of the economy. Undoubtedly, some of this is in turn related to a desire
by commercial firms and households to raise their saving rate and to pay down debt.
But are there other reasons?
What has happening to liquidity?
In the Organisation for
Economic Corporation and Development (OECD) area, money supply growth is
slowing fast, see chart a. Annual money growth is currently around 7%, down
from about 9% in 2008, and likely to decelerate further based on latest trends.
This is despite a huge expansion in liquidity by central banks, see chart b.
Indexing the size of each central bankâ€™s balance sheets to 100 in January 2007,
the Bank of England leads the way with 270 followed by the US Federal Reserve
at around 230. The European Central Bank (ECB) has risen to 170 while the Bank
of Japan scores slightly less than 100. Overall, excluding Japan, this is a
considerable easing of monetary policy by any measure.
Chart c shows the total
stabilisation costs around the world so far in the financial crisis, as
estimated by the International Monetary Fund (IMF) as a share of each countryâ€™s
annual economic output. Costs are highest in Ireland, closely followed by
the UK and US. Well behind in
spending to stabilize the financial system are Japan, Germany, France and Spain. It could be because
these countries are pumping less into their economies, so OECD money supply is
weakening. However, it could also be argued that the reason why they are
spending less is simply that their economies are less directly affected by the
financial crisis, though no less by the economic crisis.
Borrowing by households in the top four
developed economies is decelerating rapidlyâ€¦
Charts d, f, g and h
reveal what is happening to detailed lending flows in the biggest four
developed economies. A disaggregated comparison of trends in bank lending for
these countries reveals that lending to non-financial corporations and
households has decelerated everywhere apart from Japan. However, there is an
anomaly regarding lending to other financial companies where the UK trends are strongly
positive but the US, Japanese and EU
trends are negative. This is probably attributed to the severity of the
securitisation crisis in the UK, accounted for by the
large amount of wholesale funding that went on by off-balance sheet vehicles
that now require refinancing. This refinancing shows up as increased lending
but means little directly for the real economy. What does matter for economic
growth is the trend of borrowing by households and companies because this will
directly translate into decisions around consumer spending and investment.
In the UK, companies are
repaying debt and consumer borrowing growth is easing fast and likely to be in
a debt repayment situation if the current momentum persists. In the US and Germany, companies are still
borrowing but households are repaying debt. This may partly explain why
commercial bank reserves at central banks in the US, EU and UK are rising. It is
possible that it is not just that they are hoarding liquidity but that
borrowers do not want loans as much as they did.
â€¦suggesting weak economic growth and low
inflation could persist for some time
These trends suggest that
economic growth is not on the verge of a strong recovery. They also imply that
interest rates will stay low for a considerable period of time, and no
tightening is in the offing. With output still falling, inflation is not a
threat and so there is simply no reason why interest rates cannot remain low.
Also, quantitative easing, being implemented most aggressively in the US, UK and Euro area, is
another policy tool that seems appropriate. But despite its expansion in recent
months, there still appears to be a deceleration underway in money supply
growth in the OECD area and in the big four developed economies.
Markets to be tested by heavy week of US data & bond
With many of the major equity indices
hitting new highs for the year, it seems optimism abounds about prospects for global
recovery. The improvement in risk sentiment and the associated bounce in
equities have been impressive - driven higher by better-than-expected US
earnings results, improved economic data and growing hopes that a recovery in
the global economy is nigh. Just as equity markets are breaking to new highs,
G-10 bond yields are shifting higher as dealers speculate that recovery may
well bring forward possible interest rate rises and a reversal of quantitative easing.
But, as last weekâ€™s weaker-than-expected UK Q2 GDP figures highlight, it is still too
early to be confident that a fullblown and self-sustaining improvement in
growth is at hand either in the UK or, for that matter, elsewhere. This weekâ€™s
slew of economic data, particularly in the US, should cast more light on the debate.
Amongst the main releases in the US are Q2 GDP, along with the Chicago PMI, consumer confidence, house prices and
new home sales surveys. Bernanke and other Fed members will also be speaking
and the quarterly refunding will get underway. Elsewhere, in the UK the calendar is sparse, although money
supply, inflation, unemployment and various sentiment indicators are due in the
Eurozone. We expect the general tone of this weekâ€™s data to support the recent
signs of improvement. It remains to be seen, however, whether the outturns will
be sufficient to maintain the bullish equity market momentum as we head into August.
Short of very strong numbers, we doubt it.
ô€‚„ It is difficult to single out which of this weekâ€™s US economic releases is
likely to attract the most attention. The advanced estimate of Q2 GDP, however,
is probably the front runner as the market seeks confirmation from the broadest
measure of US economic activity that
conditions are improving. After the massive 5.5% annualised drop in Q1, the
pace of decline in GDP is expected to have slowed to 1.5% in Q2. While consumer
spending and investment (both business and residential) are forecast to have
dropped further, the overall outturn should have improved, courtesy of a much
reduced pace of destocking and a pick-up in net exports. Improvements are also
anticipated in this weekâ€™s Chicago PMI, new home sales and Case-Shiller house
price reports. Recent indicators suggest the US housing market has
bottomed. Still, given the overhang of unsold homes it will be a long time
before the recent improvement in housing starts and home sales translate into a
sustained recovery in house prices. Although the pace of decline may have
slowed, this weekâ€™s Case-Shiller house price report is expected to show that
house prices still dropped 17% in the year to end May. Most of this weekâ€™s
reports are likely to post an improvement, but the latest durable goods orders
and weekly jobless claims figures are likely to be exceptions. Durable goods
orders are forecast to have fallen in June, reflecting renewed weakness in
aircraft orders; jobless claims, meanwhile, are expected to have risen as the
seasonal distortions associated with the July retoolings in the auto sector continue
to unwind. Apart from the economic data, US fixed income markets also have to
contend with a resumption of government supply. A total of $109bn of 2-yr, 5-yr
and 7-yr Treasuries are due to be auctioned, along with a further $6bn of 20-yr
index-linked stock. The busy data schedule coupled with the heavy supply could
prove a difficult test for US bond markets,
particularly if Bernanke alludes to signs of recovery when he addresses a
town-hall-style session at the Kansas City Federal Reserve (televised in three
parts on Mon, Tues & Weds).
ô€‚„ In Europe, the data calendar is dominated by economic
releases on the continent. The main release will be the flash estimate of the
July Eurozone CPI due on Friday. The annual rate of Eurozone inflation is
forecast to have dropped from -0.1% in June to -0.4% this month - taking it
further into deflationary territory. In the same vein, Eurozone M3 money supply
growth is forecast to have weakened further in June, reflecting the continued
tightness of bank lending conditions - a finding likely to be echoed in the ECBâ€™s
Bank Lending survey on Wednesday. Nevertheless, given the pick-up in some of
the recent confidence surveys, the European Commission business and consumer
sentiment reports due this week hold out the prospect of some improvement.
Finally, in the UK, focus is likely to be
limited to the July CBI distributive tradesâ€™ survey and the June mortgage approvals
and net consumer credit figures in what is otherwise a quiet week for UK economic data.
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