Economics Weekly - Economic activity: levelling off or growing? Weekly economic data preview - UK inflation to fall further, while US confidence and housing data are due
Economics Weekly - 17
levelling off or growing?
It is clear that a remarkable
economic recovery is underway in Asia, led by China and India, but is the
same true of the
developed economies? Recent economic figures for Germany and France have prompted many
commentators to predict that recovery has started. But is this true or is it
more a levelling off of activity? Moreover, not only have financial markets
been expecting recovery, as shown by the strong rise in equities in recent
months, but they have been looking for it to start in Europe ahead of the US. Further, the expectation was that,
within Europe, the UK would be the first out
of recession. Currency markets in particular have been marking down the US
dollar relative to the pound, the euro and the yen.
Developed countries gdp
may have stopped falling...
What are we to make of
these perceptions in the context of the gdp figures for Q2 that have just been released?
The analysis below suggests that output may have stopped falling in the
developed economies but that recovery is still some way off. And despite
perceptions, the US looks like being the
first economy to get closer to the output level reached prior to the start of
the recession, based on consensus forecasts, in the next two years. Figures for
Q2 2009 show that economic growth in the Asian emerging markets as a whole was
about 10% annualised. Although this disguises weakness in some of the smaller
economies in the region, the Asian economies that have reported gdp for Q2 all
showed a strong rise. These include, China, up 15% annualised on Q1,
Singapore, up 21%, South Korea, up 10% and Indonesia up by 5%. Overall, the
Asian economies are showing signs of a stronger recovery than evident in the
developed economies so far. The expectation in the August Asia Pacific
Consensus Forecast is for Asian growth excluding, Australia, Japan and New Zealand, to be 4.6% this year,
accelerating to 7.8% in 2010. Consensus Forecasts for the advanced economies is
for a fall of 4.1% in 2009 and a rise of just 1.2% in 2010. But recent economic
figures for the eurozone in Q2, and within it, Germany and France, suggest that perhaps
recovery is now underway in the developed economies as well. The facts are that
eurozone gdp dropped by 0.1% in Q2 (expectations were for a fall of 0.4%) but
economic growth in both Germany and France was 0.3%. However, do
these figures mark the start of economic recovery or are they just a sign that
perhaps the worst of the falls in gdp are over?
...but an economic
recovery still seems some way off...
Focusing on the developed
economies, chart a shows that the falls in gdp have been very sharp, especially
in Japan and the eurozone and,
within the latter, Germany. On average, gdp has
declined for 5 quarters so far in this recession. Although the size of the
declines has diminished, this does not yet look like recovery. And chart b illustrates
why this is. Manufacturing output, which has led the downturn, is still well
off the level reached before the recession started. Japan has showed the biggest
fall in manufacturing activity, followed by the eurozone, the US and the UK.
These declines in the
level of manufacturing activity reflect the massive reduction in stock levels
that has occurred in the developed economies, possibly the worst in 50 years.
But the rapid pace of liquidation appears to be easing and stocks are now
therefore likely to add to gdp in the next quarter or two, even if the drawdown
does not end completely. However, absent a recovery in consumer
demand, in company
investment or in government spending, any boost to gdp from this source is
likely to prove temporary. In terms of the peak to trough fall in gdp, see
chart c, Japan has seen the biggest drop, nearly 9% so far, followed by
Germany, the eurozone, the US and France. These declines are worse than those
recorded during the 1980s or 1990s recessions, in terms of gdp falling below
potential growth. Our analysis suggests that the output gaps that have opened,
see chart d, are also larger than in the 1980s and 1990s downturns. This means
continued downward pressure on price inflation and the persistence of low
interest rates and non standard monetary policy measures in those economies
most affected by the recession for longer to ensure recovery occurs.
...a number of important
factors will prevent a rapid recovery...
The factors that stand in
the way of a rapid economic recovery in developed countries are captured by the
rise in unemployment depicted in chart e. Although the pace of job losses will
slow as economic activity levels off, unemployment will still rise as long as
growth remains below potential. This will restrain consumer spending, and raise
saving rates, already compounded by high debt levels. With consumer demand weak
and residential housing markets likely to remain under intense pressure for
some time, companies are unlikely to expand investment spending, especially in
a more constrained credit environment. This means that economic growth will
take longer to return to its previous peak. We have estimated how long that
could be for some developed economies, using consensus estimates of gdp levels
up to the end of 2010. It shows that only the US of the major economies
will return close to its 2008 gdp level by that time.
...leading to important
implications for financial markets
The implication of this
analysis is that the recovery will be long and protracted in the developed economies,
and the better performance of the Asian emerging market economies cannot be
quickly emulated. Further, the latter will lead the world economic recovery. Of
the major economies, the US seems most likely to
recover to its pre-recession level first. But this is not the trend evident in
financial markets, with the dollar currently being sold relative to the euro,
yen and sterling. That could therefore reverse, unless supported by improved
economic performance of the other areas. In addition, financial markets may be
expecting too much monetary tightening over the next two years. This implies
that inflation expectations are too high and that government bond yields couldstay
lower for longer or fall from current levels. But the rise in equity markets,
if led by the emerging markets, seems more solidly based. However, the current
commodity price trends might not be sustained for much longer if demand from
the developed economies does not come through to sustain the rise in prices
that has been seen in recent months.
UK inflation to fall
further, while US confidence and
housing data are due
Last weekâ€™s Bank of England Inflation Report
reaffirmed the view that inflation is likely to fall further in the near term, despite
improvements in short-term indicators of growth. Moreover, the Bankâ€™s forecasts
show annual CPI inflation will remain below target in the medium term if
interest rates were to move higher. This week sees the release of UK July CPI inflation,
which is expected to have fallen further below the 2% target and RPI further
into negative territory. UK official retail sales
and the CBI industrial trends are also due. In the US, housing and business
confidence indicators, including housing starts and the Philadelphia Fed business survey,
dominate proceedings. Fed Chairman Bernanke is scheduled to speak at Jackson Hole at the end of the
week. In the eurozone, last weekâ€™s unexpectedly positive Q2 growth numbers for Germany and France will be followed this week
by advance eurozone PMI and German ZEW surveys. In Japan, the= economy in Q2 is
expected to have returned to growth, but the sustainability of recovery there
is not assured.
ô€‚„ UK annual CPI inflation fell
below the 2% target only last month for the first time since September 2007. Near
term, we expect it to decline further, to 1.5% in July and potentially below 1%
in the coming months. Hence, inflationary pressures will remain weak and it
will take several years of very strong growth to eliminate the significant
output gap that has opened up. Anecdotal evidence for July retail sales has
been mixed, but we think the official figures may reverse some of the 1.2%
monthly rise in June. The CBI industrial trends survey is also due and has, in
recent months, pointed a less positive outlook for short-term growth than the
PMI survey. We expect the CBI surveyâ€™s total orders balance to rise to -50 in
August from -59, still a very weak level for this survey. The minutes of the
August 5/6 MPC meeting will be published and could show a split vote in favour
of the unexpected Â£50bn increase in the Bank of Englandâ€™s asset purchase
ô€‚„ The German and French economies expanded in Q2, contrary to
expectations, following four consecutive quarters of sharply negative growth.
Eurozone GDP still fell by 0.1% on the quarter, however, dragged lower by
contractions in Italy, Spain and the Netherlands. The advance PMI
surveys for manufacturing and services are expected to show further
improvements in August, but they are expected to remain below the key 50 â€˜no
changeâ€™ level in Germany, France and the eurozone. This
suggests that we should be cautious about underlying economic prospects,
despite the surprisingly strong Q2 GDP numbers released last week. We have
pencilled in a rise to 47.5 from 46.3 for eurozone manufacturing PMI and a rise
to 46.5 from 45.7 for services PMI. The German ZEW survey of investor
confidence fell unexpectedly last month to 39.5, but the renewed upturn in risk
appetite in the past month means that it could increase to 50.
ô€‚„ US business confidence surveys have improved in recent months,
raising hopes that the economy could return to growth in Q3. Housing indicators
have also been stronger. However, the cautious tone regarding economic
prospects in the FOMC statement last week and unexpected declines in retail
sales and consumer confidence reaffirm our view that the Fed is not likely to
tighten policy anytime soon. The Philadelphia Fed business survey fell slightly
last month, but the trend has remained higher. An improvement in this survey in
August is expected. This publication is preceded by the Empire manufacturing survey
at the start of the week, which again has trended higher in recent months.
Moreover, the Conference Boardâ€™s index of leading economic indicators is
expected to show a fourth consecutive month-on-month increase. Housing market
indicators have also improved lately. Housing starts may rise to 600k, the
highest this year, while the NAHB homebuilders confidence index is also
expected to rise. Fed Chairman Bernanke will round off the week by speaking at
the Jackson Hole Conference on Friday.
ô€‚„ Japanese Q2 GDP is expected to rise for the first time in five
quarters. We see a quarterly rise of 0.5% (or 2.0% annualised). The positive
outturn is likely to reflect recovery in export markets, but its sustainability
remains open to question, given weak indicators of domestic demand. Moreover,
even with stronger Q2 growth, the level of output will be significantly
lower than the peak, raising the risk of continued protracted deflation in Japan.
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