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Economics Weekly - Review of 2009: Back from the brink, Weekly economic data preview

Economics Weekly - 11 January 2010


Review of 2009: Back from the brink


2009 is likely to go down in the annals of history as the year in which policy makers successfully averted a global economic catastrophe. It now seems difficult to believe that it was just over a year ago that the world economy was looking into the abyss. The contagion resulting from the earlier collapse of Lehman Brothers was casting a dark cloud, equities were hitting new multi-year lows and a tightening in global liquidity was threatening to send what was already a global downturn into a depression.


Yet twelve months on, the outlook has improved markedly. Courtesy of the aggressive actions of

the major governments and central banks, and the resilience of some of the emerging

economies, an ongoing downward spiral in global economic activity has been prevented. As we enter 2010, global GDP is again expanding, the major equity markets have posted impressive bounce-backs, and the provision of global credit, while still hampered, has undoubtedly improved.


Consensus proves too optimistic...

Given the turnaround, it is perhaps surprising that the official outturns for growth for last year

generally proved far weaker than the consensus estimates taken at the end of 2008 (see chart a). What almost all economists clearly (and perhaps not surprisingly) missed was the magnitude of the unprecedented downturn in the first three months of 2009. In the first quarter alone, the level of GDP dropped by 3.5% in Germany, 3.0% in Japan, 2.5% in the UK and by 1.6% in the US. The quarterly falls effectively wiped out the equivalent of a whole year of trend growth, if not more, for most of these economies.


But it was a year of two halves, with a massive fall in global output in Q1 nipped in the bud by unprecedented policy stimulus Credit for the recovery must go to global policy makers for their swift and aggressive action But it remains to be seen whether they will be quite so successful in withdrawing the stimulus


...but conditions have improved

Since the second quarter, however, conditions have clearly improved. The decision of the major central banks to embrace unconventional policy measures – such as quantitative easing – from the end of March marked a major turning point. While consensus GDP forecasts were revised

sharply lower in response to weaker economic data in the early part of last year, they subsequently bottomed out as the stimulus measures began to take effect. Japan, Germany and France all returned to positive growth in Q2, and the US and euro zone in Q3. The laggard was the UK, where growth forecasts were revised steadily lower for most of last year. Over the past quarter, however, it too appears to have emerged from recession.


While the turnaround in the fortunes of the global economy has been impressive, the performance of global asset markets, particularly equity markets, has been even more striking. The improvement in economic confidence and the flood of global liquidity unleashed by the unconventional monetary policy measures precipitated a marked turnaround in global equities. By the end of 2009, the US S&P500 had risen by 23%, the FTSE Eurofirst 300 by 26% and the UK FTSE 100 index by 21%. From their early March lows, the gains were closer to 60-70%.


Inflation drops sharply

As with the GDP forecasts, the consensus expectation for CPI inflation for most of the major

economies in 2009 also proved far too high (chart b). Last year saw the US and euro zone

experiencing record price falls and Japan reAny entering deflation. A notable exception was the UK., where the headline rate of UK CPI bottomed at a five-year low of 1.1% in September. However, the annual RPI, which captures house price depreciation, fell to a record low of -1.6%. As we move through 2010, economists’ opinions over the global inflation outlook differ between those that believe that spare capacity and weak growth will keep inflation pressures at bay, and those that think rising commodity prices, economic recovery and the flood of global liquidity will unleash a global inflation shock.


10-yr government yields rise, as expected

Although both GDP growth and inflation proved weaker than expected in 2009, the consensus  estimates for 10-yr government bond yields proved remarkably accurate (chart c). Over the

year, 10-yr government yields were pushed higher by signs of economic recovery and rising

government bond issuance to finance increasing fiscal deficits. In the UK, 10-yr gilt yields ended the year around 100bp higher at 4.0%. The rise occurred despite the £175bn+ of gilt purchases

by the Bank of England as part of its Quantitative Easing programme. The fact that gilt yields still

rose highlights the vulnerability of the gilt market (and other government bond markets) once policy makers start to reverse the policy stimulus.


Fall in the US$ imparts additional stimulus

In the currency markets, 2009 saw a renewed weakening of the US dollar versus the majors – except against the yen, where a late US dollar rally pushed the currency pair back above its value at the start of the year (chart d). The fall in the US dollar imparted additional stimulus to the US and those countries with dollar-linked currencies by boosting their competitiveness. In line with other asset markets, currency volatility dropped back from its earlier peaks – a further reflection of the improvement in risk appetite. More generally, sterling was a noticeable underperformer over the second half of the year. Sterling weakness was a key theme for the UK in 2009 and is likely to

remain so over the coming years, as the UK seeks to rebalance its economy away from domestic demand towards net exports.


A sigh of relief that it wasn’t a lot worse

In sum, last year was an exceptionally weak year for the world economy, with the full-year outturns for GDP growth dropping to multi-decade lows. That said, most can breathe a sigh of relief that it was not much worse. Courtesy of the aggressive actions of policy makers, financial market confidence and, to a lesser extent, economic confidence have bounced back. While policy

makers can be applauded for their swift and coordinated response, it is too early to be confident that we are out of the woods. It remains to be seen whether policy makers can manage an orderly withdrawal of the unprecedented stimulus without tipping the world back into recession or

unleashing an inflation shock. This, perhaps, is the single biggest uncertainty facing the global economic outlook as we head through 2010.

Adam Chester, Senior UK

Macroeconomist, Corporate Markets


Editorial comments to:

Trevor Williams

Chief Economist

Lloyds TSB Corporate


Economic Research

10 Gresham Street

London, EC2V 7AE

Tel: +44 (0)20 7158 1748


Weekly economic data preview -11 January 2010


Industrial production data to underscore diverging performances

􀂄 The UK data calendar kicks off early on Tuesday morning with the release of the December BRC retail sales monitor and the RICS housing market report. November retail sales were surprisingly weak since there was an expectation for consumers to bring forward expenditure ahead of the rise in VAT on 1 January. But the issue may have been more relevant for the December trading period, with retailers campaigning hard to boost sales ahead of the VAT rise. We forecast a rise in the BRC’s rate of annual sales growth, to 5% from 4.1% in November. Turning to the RICS survey, we look for the headline house price balance to be unchanged at +35 in December (after rising for nine straight months), though the fall in the price expectations balance in the previous report presents some downside risks. For Tuesday’s trade data we expect a small (£0.4bn) narrowing in the headline deficit to £6.7bn in November and for inflation-watchers, the detail on import price developments will be of interest. We expect Wednesday’s industrial production data to show a 0.2% monthly gain in output during November, broadly in line with PMI developments. However, that would still leave the three-month-on-three-month rate in negative territory in November (at -0.3%), so a strong monthly gain will be needed to have been registered on the official data for December to ensure that industrial production makes a positive contribution to GDP during Q4 as a whole.


􀂄 In the US, the week begins on a quiet note, with no significant data or events scheduled until Wednesday, when the Federal Reserve releases its latest Beige book. The content - which details current economic conditions by sector - will be used as the basis of discussion for the FOMC meeting on 27 January. On Thursday, the December retail sales report is published. The much stronger-than-expected gain of 1.3% in November was interpreted as a signal that consumer confidence may have improved on signs of a recovering labour market and some stabilization in the housing market. We expect this trend to persist and have pencilled in a 0.6% monthly gain for December. CPI data for the same month (Friday) are forecast to show a 0.2% gain at the headline level, pushing the annual rate of inflation up one percentage point to 2.8%. But, with unfavourable energy price base effects working through the data, the rise in core inflation is expected to be far less pronounced, at 1.9% from 1.7%. Also on Friday, a 0.7% m/m rise in December industrial production should ensure that the sector made a positive contribution to Q4 GDP growth, while January readings for the Empire Manufacturing and the Michigan confidence reports are expected to show that the US recovery continued to gain traction into the New Year.


􀂄 We look for an unchanged refinancing rate of 1% at Thursday’s ECB meeting. In the press conference, President Trichet is expected to repeat the view of the Governing Council that the economic recovery path going forward will be ‘uneven’. To date, the ECB has been at pains to stress that the measures taken to start unwinding its ‘unconventional’ policy measures do not represent an attempt to influence money market rates such as EONIA

(which would send a message of imminent tightening to financial markets). The latter looks set to occur during the course of this year, but not as early as January’s meeting. On the data front, Eurozone industrial production (Wednesday) is forecast to post a 0.4% rise in November, though that would leave the three-month-on-three-month rate of growth at -1% (down a touch from -0.9% in Q3). In fact, assuming our forecast for November is realised, output would have to grow by a fairly chunky 1.7% in December alone to avoid detracting from GDP growth in the fourth quarter. At the end of the week, the final estimate of December CPI is expected to be confirmed at 0.9% on an annual rate, up from 0.5%, with the core rate of inflation broadly unchanged at 0.9%.

George Johns, UK Macroeconomist



Economic Research,
Lloyds TSB Corporate
10 Gresham Street,
London EC2V 7AE
0207 626 - 1500


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