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Economics Weekly -World growth still on track Weekly economic data preview - Mixed signals for global growth

Economics Weekly 26 July 2010


World growth still on track


Fears are growing that the global economic recovery is already running out of steam. A plethora of economic data in a number of countries over the last month or so have shown that economic growth is slowing. In the US, the housing market is under renewed downward pressure as official support is gradually withdrawn. At the same time, US employment growth remains sluggish. In Europe, the problems of Greece, Portugal, Italy and Spain dominate the agenda as high levels of government debt have led to a crisis of confidence in financial markets about sovereign risk. Even in the fast growing emerging market economies, survey data suggest that the pace of growth is easing. But this is not in fact unusual: no recovery occurs in a straight line, and this one is no exception. This means that setbacks during the recovery phase should be expected and are not a reason for doubting it and expecting a double-dip.


We look at some of these issues in this Weekly, concluding that despite the setbacks global growth remains on track for a 4% plus rate this year. However, growth will likely settle at a lower pace in the second half of 2010 than recorded in the first half. Unfortunately, this leaves a risk that financial markets overreact to signs of renewed economic weakness, with bond yields falling further and equity markets pricing lower company earnings growth. Our forecast for world growth suggests that this would be a mistake, as global growth is set to be around 4.5% both this year and next. Massive fiscal easing, sharp cuts in interest rates, a reopening of trade supply routes, shut down temporarily by fears about trade finance, and injections of liquidity by central banks are doing their job and boosting recovery. But these effects behave like a wave, and after an initial burst, growth will slow before resuming again. This does not mean that recovery has ended; more like a pause for breath before a resumption.


However, it is clear that Purchasing Managers’ Indices (PMIs) in the last two months have taken a bit of a tumble, see chart a. The correction is almost uniform, with the sharpest declines in the US, UK, euro zone and China, where the drop has been sharpest. Supporting evidence of the fall can be found in data for housing markets in the US and China, and in consumer and retail spending trends in the euro zone. In the UK, PMIs have also headed lower, with signs that housing activity is weakening. However, preliminary Q2 UK gdp data highlight that the recovery remains on track in spite of the evidence from the PMIs, with a rise of 1.1% in Q2, to a 1.6% annual rate, the first positive annual rate since Q2 2008. Admittedly, we have serious doubts about the sustainability of the pace of recovery implied by the Q2 data, as high frequency data for July and Q3 are hinting at a significant cooling.


A closer look at the PMI data for the US, euro area, China and the UK show that what they are showing is a deceleration in the pace of growth. Hence our belief is that what we are witnessing after a few quarters of rapid economic activity in many economies is a slowing in the rate of growth and not an outright decline. Aside from Spain, all of the advanced economies in the G10 are expected to grow this year and next. Still, differences do exist between the advanced economies and the developing economies, as the latter grow rapidly. One of the reasons for the growth disparity is that the advanced economies are encumbered by the after-effects of the worst financial crisis to hit them since the Great Depression, on the balance sheets of households, companies and governments. It would be naïve however to believe that this was the sole reason for the growth disparity as this was evident well before the financial crisis, when growth rates in the emerging countries were two to three times faster. More scope for catch-up, vast supplies of cheap labour and strong productivity allied with better governance and more open global markets, are all behind the faster growth of the emerging market economies.


The latter are expected to grow by 7.4% this year and the developed economies by 2.3%, and this difference persists next year as well. It is also striking that the pace of global growth is expected to almost remain the same next year, despite weak price inflation. Our forecast shows that global price inflation not only remains low but falls further in 2011. What causes this is a tighter policy stance in the emerging economies. This should be seen as good news, as it makes growth more sustainable in these economies over the longer run.


Nevertheless, it is too soon to sound the all-clear for global growth, as issues around sovereign default risk in Europe, fiscal austerity plans and high levels of unemployment could keep private sector spending weak and limit the recovery.

However, doubts about the recovery are keeping bond yields low, which in time will help foster recovery. In addition, the lack of a more robust recovery in the advanced economies is acting to keep down global commodity price inflation. This is acting in turn to limit the need for the emerging market economies to tighten policy even more aggressively, as inflation is lower than otherwise. The upshot is that global growth is still on track for a ‘v’ shaped recovery, but expect a weaker second half in 2010.


Trevor Williams, Chief Economist,

Corporate Markets


Weekly economic data preview 26 July 2010


Mixed signals for global growth


􀂄 After last week’s MPC minutes, retail sales and GDP reports, the UK data calendar thins out considerably this week. The latest CBI Distributive Trades and housing/lending surveys provide the main focus in a week of second tier data. The CBI is expected to report that retail sentiment picked up slightly in July, boosted by the hot weather and sales of seasonal clothes lines. We expect the net balance of retailers reporting a rise in sales to have risen from -5% to +3% this month. In keeping with signs that the UK housing market may be starting to soften again, the Nationwide house price index is forecast to have dropped by 0.4% in July; mortgage lending and approvals in June are also expected to have softened.


􀂄 By contrast, after Friday’s EU bank ‘stress tests’, this week sees a variety of releases across the euro-zone, including euro M3 money supply, the latest European Commission surveys, preliminary July CPI data and July German unemployment figures. Euro area monetary statistics are of particular interest as financial market volatility has a direct bearing on bank funding costs. Surprisingly, bank lending growth to the euro-zone private sector picked up modestly in May, despite extreme market volatility. But it is not clear this trend will continue uninterrupted going forward. Meanwhile, we look for a modest improvement in the Commission’s economic sentiment index to 99.0 from 98.7, amid continued healthy demand from emerging Asian economies for euro-zone exports. On inflation, the “flash” estimate of euro-zone annual CPI is predicted to register 1.7% in July, from 1.4% previously. At July’s ECB press conference, Jean-Claude Trichet noted that some pick-up in price pressures was likely in the short term.


􀂄 In the US, the advance estimate of Q2 GDP on Friday provides the data highlight of the week, although before then other more timely releases will also draw strong interest. We look for annualised GDP growth from 2.7% in Q1 to 2.8% in Q2, underpinned by rising business investment. This release will also contain annual revisions to GDP growth for the past three years. The Fed’s Beige Book, on Thursday, is likely to underline the dovish tone of the June FOMC minutes and Fed chairman Bernanke’s testimony last week. Together with a likely softer reading for July consumer confidence earlier in the week, it raises the possibility that GDP growth may remain relatively subdued in the current quarter. The economic slowdown appears to be weighing heavily on the housing market, although the latest data also reflect the expiration of key government initiatives. While we look for a small rise in June new home sales on Monday, this comes after a record 33% drop to an all-time low of 300,000 in May. In other events, the Treasury will auction $104bn of notes this week.


􀂄 Elsewhere, key Australian price data are out this week. CPI inflation is forecast to rise from 2.9% to 3.3% in Q2, largely reflecting a 25% increase in tobacco excise taxes, as well as higher interest rates and health costs. While this is likely to take inflation above the upper end of the RBA’s 2-0%-3.0% target range, the detail of the inflation report, rather than the headline number, is likely be more influential in determining whether the RBA follow up with a rate rise at its next meeting in August.


􀂄 Elsewhere in the region, the South Korean economy is expected to have expanded by a strong 1.2%q/q in Q2, a rise of 6.8% on the year. Although slightly slower than the 2.1% quarterly growth registered in Q1, this would still represent a strong outturn and justify interest rate increases to contain building inflationary pressures.


Economic Research team



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