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Monday December 19, 2005 - 11:22:34 GMT
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Forex: Economic forecasts of 2005 were accurate in places

Economics Weekly: Economic forecasts of 2005 were accurate in places

How has the 2005 economic performance surprised?
How did growth, inflation and interest rates for the major economies turn out in 2005 (on latest estimates) compared with expectations made by around 30 economists at the start of the year? We analyse this by comparing the consensus forecasts made in the December 2004 issue of Consensus Economics for 2005 with those for the same year in the December 2005 issue.

Growth trends are mixed...
US and Japanese economic growth in 2005 have both exceeded expectations made in December 2004. The UK has grown less than expected, along with the EU. Growth has turned out to be higher in Japan than in the UK or the EU, even though it was expected to be the slowest expanding economic entity in 2005. However, growth in the UK has still comfortably exceeded that of the euro area, where growth of 1.5% is now expected against last yearís expectation of 1.7%, the rate the UK is now projected to record. It should be noted that Ĺ% of the UK undershoot of the 2.5% growth that was expected a year ago is down purely to data revisions, so the actual undershoot is just 0.3%. The US economy has outperformed, even though it experienced damaging hurricanes, due to a strong housing market that buoyed consumer and investment spending. Japan outperformed because of fast rising exports to China, which seem to have kick-started the domestic economy as well.

...but inflation is generally higher than expected
What about inflation? As to be expected, faster growth than was expected in the US has meant that inflation there has overshot projections made a year ago compared with those made now (with 10 months of the yearís data now in). But inflation was also higher than expected in all the other areas as well, apart from Japan. In the latter though the difference is hardly large, with prices now expected to fall by 0.2% against last yearís expectation of 0.1%. The reason for the overshoot in all the other economies is clearly due to the fact that oil prices are significantly higher than was expected a year ago. Oil prices in December this year are at $60 a barrel compared with $42 last year, a rise of 43%. But US consumer price inflation has overshot most of all, even though, given the increase in oil prices, it is remarkable that inflation remains so low overall.

Short term interest rates are higher than projected in the US...
Interest rate trends though have echoes of the inflation profile. Chart C shows that short term interest rates (based on the Treasury bill rate) in the US have ended up over twice as high as was expected a year ago, at just over 4% compared with 2%. This actual outcome is to be expected, given faster than expected growth and higher than expected inflation. Although inflation is also higher than expected in the UK, economic growth there is lower than was expected as well, so it is no real surprise that short term interest rates are lower than was expected, though not by much (4.5% now against 4.9% projected last year). For the eurozone, the current short term interest rate is exactly what was expected a year earlier. This means that it is US economic indicators and interest rates that have surprised most to the upside.

...as were long term interest rates...
What about long term interest rates, given the inflation outcome? Given the preceding trends, it is no surprise to see that only in the US are long term interest rates higher now than was expected a year ago, see chart D. Interest rates in Japan are spot on what was projected. Despite slightly higher than projected inflation in the UK and euro area (which was compensated for by having weaker than expected economic growth), long term interest rates have turned out lower than projected in both.

...in summary, these trends may have driven the US$ in 2005
In summary, these economic outcomes go some way to explaining the strength of the dollar over the year. An outperformance of the economy and higher short term and long term interest rates than were expected have combined with lower than expected interest rates and growth in the euro area and the UK to push the dollar higher than many anticipated. Although Japanís economy performed much better than expected, its interest rates are still at zero at the short end and only 1.7% at the long end, so the yen has been sold versus dollars. Some of this pattern may now be changing. In another weekly brief, we will look at what forecasters are looking for in 2006.

UK economic indicators
UK economic indicators this week are expected to show that the economy grew by just 0.4% in Q3, with data due on Friday. But the public finances will worsen, data on Tuesday, with the government typically borrowing heavily in November. MPC minutes of the December meeting could show that they speculated about cutting interest rates in the face of weak growth and a weak labour market. After dismal figures, it may that CBI retailers are finally expecting sales to improve over the holiday period.

Trevor Williams, Chief Economist
trevor.williams@lloydstsb.co.uk
www.lloydstsbfinancialmarkets.com
Lloyds TSB Bank,
Financial Markets
Division,
Faryners House,
25 Monument,
London EC3R 8BQ
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