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Monday September 7, 2009 - 11:28:45 GMT
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Economics Weekly - Increased liquidity boosts recovery hopes; Weekly economic data preview - MPC meeting headlines week dominated by supply & policy comments

Economics Weekly - 7 September 2009

 

Increased liquidity boosts recovery hopes

 

 

Global economic recovery gets underway

A global increase in liquidity has been underway in an attempt to kick start economic recovery ever since the depth of the financial crisis was understood. It appears to be working. A range of countries have recorded a rise in economic growth in Q2, including Germany, France and Japan, see chart a. For many of them, this was the first rise in economic activity in over a year, after sharp consecutive quarterly declines. However, the US and the UK recorded falls in economic activity in Q2. It is also noticeable that emerging market economies are bouncing back more quickly than developed economies, with annual gdp in Q2 up by 7.9% in China, by 6.1% in India and quarterly increases in Singapore of 20% and 9.7% in South Korea. In short, there are solid signs that conventional and unconventional policy loosening is helping to foster a global economic recovery.

 

US and UK economies still in recession but set to expand in Q3…

The predominant message from recent economic data in the US and the UK is that both economies are likely to exit recession in Q3. Focusing just on the UK, there was a rise in the services Purchasing Managers Index (PMI) for July to 54.1, up for the fourth month in succession and the highest level since September 2007. Although the manufacturing PMI fell from 50.2 to 49.7, and the construction PMI was 47.7 (up from 47.0 in June), the weighted average of the three PMI’s (based on their shares of gdp) was 53.7 in July and so suggests that the economy will expand in Q3, see chart b. A similar story can be told for the US, albeit less based on the services ISM than on the manufacturing ISM and other indicators.

 

...aided by injections of liquidity from the public sector, which is also boosting financial markets…

It is also increasingly evident, however, that the increase in public sector liquidity is not only helping to restart economic growth but is also boosting financial markets. Using the UK as an example, since quantitative easing began in March 2009, financial market activity has generally shown a steep rise. Take the FTSE 100, which is up by about 40% from its March low, see chart c. Is it just a coincidence that the rise started from the time that the Bank of England (and Fed) initiated quantitative easing (QE)? Sterling corporate bond issuance has also surged, and the yield on investment grade bonds has fallen by about 2 percentage points, to 6% or so since QE. Government bond yields have also fallen back recently, as QE has put a rising share of the amount of gilts outstanding into the Bank of England’s hands, after rising initially on worries about price inflation, see chart d. Incidentally, the QE programme may also explain the seeming conundrum of rising equity prices and falling or low gilt yields.

 

Taken together, or even separately, these trends suggest that investors have switched cash from selling gilts to the Bank of England into equities and bonds. This has enabled corporate issuers in these markets to take advantage of the increased demand to sell new equity and bonds. This is of course good news for the economy. It implies fewer bankruptcies, less financial problems and more investment than otherwise (less cutbacks in spending), meaning lower unemployment and so less economic distress. To that extent, it means that QE is helping economic recovery in a broader sense. However, as the chart shows, some of the borrowing by companies from the capital markets is being used to repay bank loans, see chart f. It seems therefore that recent debt issuance is predominantly a balance sheet restructuring exercise by firms – vital though that may be – rather than a way of raising finance to boost investment spending, as shown by the record fall of 10.4% in business investment in Q2.

 

…leading to more willingness to take risks, indicating a rise in confidence and lower financial market stress…

Financial market confidence is also being reflected in a rise in the willingness of participants to invest in riskier assets. Our Lloyds TSB Corporate Markets Risk Appetite Index (RAI) - which measures returns and volatility on various asset classes - shows that there has been such a sharp rise in the willingness to place funds in higher yielding instruments that the index has fallen into negative territory. (A fall in the index represents a rise in risk appetite). A negative outcome for the index simply means that the willingness to get out of safe, lower yielding assets, into riskier more volatile but higher yielding assets, is the highest it has been since July 2007. In short, financial market stress has fallen sharply since QE was initiated – also one of its aims.

 

…but the central bank may still have to maintain its current loose monetary stance to ensure economic recovery

But the Governor of the Bank of England has said that the main aim of QE is to increase M4 money supply, and this has not happened – or, more accurately, it has not happened yet, and could hence require more QE than the £175bn so far announced, to ensure that it does. Debt repayment or deleveraging by households and companies still seems to be occurring, however, in spite of QE. Households repaid consumer debt in July, the first time this has happened since the records began to be kept on this basis in 1993. Companies repaid debt as well, amounting to £8.4bn in July, a fall of 1.7% in bank lending to firms that month and the biggest decline since 1997.

 

All this suggests that QE is unlikely to be quickly abandoned and that a further rise may occur in November by when the current allocation of £175bn is planned to be spent. This seems prudent, as the last thing the economy needs is a damaging rise in long term interest rates or a loss of financial market confidence just as recovery seems most likely to be getting underway.

Trevor Wiliiams, Chief Economist, Corporate Markets

 

Weekly economic data preview  7 September 2009

 

MPC meeting headlines week dominated by supply & policy comments

The coming week looks set to be dominated by central bank meetings, reports and announcements. In the UK, the monthly meeting of the Monetary Policy Committee (MPC) gets underway on Wednesday, with all eyes on whether the committee could spring another surprise after its decision to increase the scale of quantitative easing by a larger-than-expected £50bn last month. In the US, the next FOMC meeting is not until 23 September, although this week sees the release of the regional summary of economic conditions produced for that meeting, the so-called ‘Beige book’; various Fed members, including Lockhart, Kohn and Yellen, are also due to speak, potentially offering the first Fed perspectives on the economic outlook since last Friday’s mixed payroll data. To round off, the European Central Bank is due to publish its latest monthly report, while various ECB speakers are out in force, most likely to underline the cautiously upbeat message communicated by President Trichet last Thursday. Apart from policy comments, it is a heavy week for government bond supply: the US Treasury is due to auction $70bn of government term debt, while in the UK the DMO is set to issue £3.75bn of 10-yr gilts. On the data front, the calendar is largely limited to industrial production and external trade figures.

 

􀂄 Although the MPC sprung a surprise last month, it is unlikely to do so this month. Recent developments have been broadly in line with the forecasts outlined by the committee in its latest Inflation Report, and implicit in its decision to raise the QE target to £175bn last month. As such, Bank Rate looks set to be left unchanged at 0.5% and the QE target reaffirmed at £175bn. There is an outside chance, however, that the MPC discusses the possibility of cutting the rate at which central bank reserves are remunerated (following the example set by Sweden, which set a negative interest rate on revenues last month). The Governor recently hinted that the MPC could do so as a way to encourage banks to draw down reserves and so boost private sector lending. Ahead of the MPC announcement, the focus in the UK is likely to be on industrial production and August PPI reports. Given the rise in the output component of the July manufacturing PMI, industrial production is forecast to have posted a further gain. Meanwhile, producer input prices are expected to have rebounded last month in response to the fall in sterling and higher oil prices. Firms output prices, however, are likely to have posted a more modest gain, reflecting the continued difficulty manufacturers are having in passing on price increases in the current environment. Also this week, the UK visible trade balance is due and the NIESR will be publishing its latest rolling quarterly GDP estimate for August. Having reported a fall of 0.4% in July, the August figure will be watched closely as other recent data suggest the Q3 GDP outturn could be positive.

 

􀂄 In the euro area, industrial data dominate what is otherwise a light economic calendar. Further strong increases in Germany factory orders and industrial production are expected for July. These, coupled with an anticipated improvement in industrial production in France, should presage a decent rise the EU-16 production figures early next week. While manufacturing conditions have clearly improved - helped by a rebuilding of inventories - as ECB President Trichet noted last week, it remains too early to be confident the recovery across the region will be sustained. Apart from the industrial data, the final German CPI for July is also due - the annual rate is likely to be confirmed at 0.0% - along with the July trade data for Germany and France. We expect the trade surpluses of both countries to have posted a slight improvement, consistent with the rise in industrial production forecast for July.

 

􀂄 Trade data are also due in the US, in what is a holiday shortened week due to Monday’s Labour Day holiday. We expect the US trade deficit to have remained broadly unchanged at $27.3bn, with both imports and exports posting gains. The latest consumer credit, import price and Treasury budget balance are also released. The budget deficit will again make for alarming reading: in August the deficit is forecast to have risen to $150bn, compared with $111bn in August last year. Given the need to finance a widening budget gap, the US government is issuing a further $70bn of Treasuries this week across 3-yr, 10-yr and 30-yr maturities.

Adam Chester, Senior UK Macroeconomist

 

Economic Research,
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