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Economics Weekly - Commodity prices unlikely to be affected by the credit crisis; Weekly economic data preview -Focus on UK consumer confidence, US data and Fed speakers

Economics Weekly


Commodity prices unlikely to be affected by the credit crisis


Commodity prices are rising, despite credit concerns

Commodity prices seem to be holding up remarkably well to the crisis in the financial markets. Is this because it is only a matter of time before they get impacted, or because the financial problems are overstated insofar as they will affect economic growth or is it that growth in the emerging market economies is so strong that it can shrug off any slowdown in the developed economies? This may not be a question that can be answered without more time to assess the impact of the credit crisis on banks. However, the facts are that the global economy seems to be marching on and any credit market impact is being felt in the developed economies and not in the emerging markets, where the marginal rise in demand for commodities seems to be coming from. In our opinion, it is a combination of fast economic growth and a bigger share of commodity demand from the emerging economies that explains why the effect of the sub prime crisis will be small at a global level on prices. It is this fact that explains why commodity prices seems to be untroubled by the continuing turmoil in global credit markets. As a result, insofar as commodities are an asset class, there might even be a renewed flow of investment into the segment.


Uncertainty remains, but global growth is solid, led by the emerging economies…

Oil prices are at a record high in nominal terms and approaching the all time high reached in 1979/ 81 in real terms as well. Gold prices are above $720 an ounce; equity markets have shown a modest correction but no more than that, while government bond markets are seeing falling yields yet corporate spreads remain wide. What is going on? Part of the reason why oil prices are so high is that global growth remains strong, and, as chart a shows, the price of commodities and world economic growth are closely linked. But why, if growth in the developed economies is set to slow in 2008 (something, incidentally, that we do not believe is true for the US economy next year compared with 2007), is demand for commodities so strong? The reason is strong demand growth from the emerging market economies, which is expected to persist. This fast growth has also meant a sharp fall in stock levels for a range of commodities, further fuelling price inflation. This is one reason why the rest of the world will not join the US in cutting interest rates and why long term bond yields rose in the US when short term rates were cut to 4.75% on 18th September, there is concern about future consumer price inflation from the pace of economic growth and higher commodity prices. Charts b, c and d show that economic growth is not just strong in the large economies of China, Brazil, India and Russia, but in a range of smaller emerging economies from every continent in the world and this is boosting the equity markets and exchange rates of these countries.


and so commodities, which they are increasingly producing and using, are unaffected by the global credit squeeze

One example of why growth in the emerging markets is more significant for the world economy than in the past is that Chinese consumption of four out of the five most basic food, energy and industrial commodities now outstrips that of the US. Our charts illustrate this point more clearly, with production and consumption being dominated by the new emerging market economies. Charts e, f, g, h, i and j show that the biggest producers and consumers of commodities from metals used in production, to energy and food are a range of emerging market economies. It is this that makes it unlikely the world will suffer anything more than the mildest of slowdowns from the credit crisis, if at all. But it also means that price inflation is more of a threat to global economic stability than at any time perhaps in the last decade. This implies higher, not lower average interest rates going forward. As a financial market strategy, it also implies further flows into commodity type investment products.

Trevor Williams, Chief Economist


Weekly economic data preview


Focus on UK consumer confidence, US data and Fed speakers

The ongoing fallout from the credit crisis and the broad based decline in the dollar will still cast a shadow over the economic calendar this week as market participants consider the implications of a weaker dollar and worry about the downturn in US housing for the global economy. Attention in the UK will centre around the latest surveys on house prices and consumer confidence, and what the instability in financial markets means for UK base rates. The next MPC meeting is still two weeks away but the fact that market participants have started to debate the possibility of an earlier rate cut than 2008 merits some attention. The minutes of the September BoE MPC meeting revealed that members on the committee now believe that inflation risks have receded. If the Bank similarly concludes that risks of a slowdown in economic growth have intensified, then a rate cut could indeed be brought forward. We stick to our original view, for now, that an immediate cut in base rates cannot be justified by economic data and will not occur until 2008, possibly May. However, we will be on alert to a turn in incoming data and conditions in money markets which could warrant an earlier move


• House prices and consumer confidence are two of the indicators that will attract attention in the UK this week. Demand for UK housing has been reported by the RICS to be tapering off in August with the balance of buyers vs sellers falling in negative territory for the first time since 2005. A month of falling house prices this summer has already been reported by the Rightmove property website, so it should be no surprise to see a weaker set of numbers from the Nationwide on Thursday. Retail sales data for August surprised to the upside last week and suggest that consumer confidence is holding up, even if sales were supported by heavy discounting . The CBI distributive trades survey for September is due on Thursday and may offer a glimpse of retail turnover this month and expectations for the final quarter of 2007. To what extent the drama for customers of Northern Rock has affected the mood among the broader public may be captured in the Gfk consumer confidence survey on Friday. An update on the state of public finances for August is due on Monday. The final estimate of Q2 gdp will be released on Wednesday.


US data and Fed speakers are likely to make the biggest impact on financial markets for a second consecutive week. The Fed cut interest rates by 0.50% to 4.75% last week and explained that this was effectively an insurance against a possible further deterioration in the housing market which could impact the wider economy. With this in mind, markets will focus on consumer confidence on Tuesday and durable goods orders on Wednesday. Existing home sales will be published on Tuesday and new home sales will be released on Thursday. A further decline in sales is likely, but this is something the Fed already pre-empted last week with its surprise 0.50% move in fed funds. Market participants will also concentrate on the latest figures for the PCE index or the Fed's preferred measure of core inflation. Concerns that last week's rate cut could stoke inflation sparked a rise in long term bond yields and lifted the gold price to a 28-year high. Personal spending and construction data are due on Friday. Fed speakers will attract at least as much attention as the data for clues about the direction of US interest rates.


• Tentative signs that the euro zone economy may be starting to feel some pressure from the credit crunch or from earlier ECB rate increases emerged on Friday when the flash PMI indicators of manufacturing and services activity fell to a two year low in September. This will reinforce the view that growth has already peaked. With €/$ strengthening above 1.41 last Friday, a negative surprise from the German IFO on Tuesday could make it harder for the ECB to justify its hawkish stance and would undermine the prospect of another rise in euro zone interest rates this year. Preliminary euro zone CPI inflation for September is due on Friday and may show a rebound from 1.7% in August close to 2.0% due to statistical base effects and record oil prices. Euro zone M3 money supply data for August is due on Thursday and may show some distortion from higher than usual demand for short term instruments following the flight-to-quality from risky assets last month.

Kenneth Broux, Economist


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


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