United States of America
The downside risks to the US outlook have increased during the past month casting doubts on the expectation of a gradual US economic recovery in the second half of the year. The persistent recession in the housing sector-in particular the subprime mortgage market- exerted increasing downward pressure on credit and equity markets, with the fallout affecting not only the US but spreading to global equity, bond and commodity markets, and precipitating fears of a global economic slowdown. The Fed, along with other central banks took measures to inject liquidity into the money markets (to the tune of $154 billion on 9 August and $135.7 billion on 10 August) in an attempt top avert a credit shortage.
In general, US economic indicators in July were mixed. On the positive side, the advance reading of 3.4% seasonally adjusted annualized quarterly change in real GDP in the second quarter showed that the economy had recovered from the meager 0.6% pace in the first quarter, as exports, commercial construction and government spending propelled growth. Consumer spending, which accounts for about 70% of the GDP, slowed to a 1.3% annual rate from 3.7% in the first quarter. In contrast, the trade deficit narrowed to an annual pace of $577.9bn in 2Q from $612.1bn in 1Q such that net exports contributed 1.18 percentage points to growth after subtracting 0.51 points in Q1. Residential investment continued to detract from growth (0.49 percentage points from over one percent in 1Q). Thus, the drag from housing continues for the sixth consecutive quarter but at a diminishing pace. Both new home and existing home sales declined further in June, the latter by 3.8% to an annualized rate of 5.75 million units, the lowest level in almost five years. The Fed lowered its forecast for economic growth to 2.25-2.5% in the fourth quarter y-o-y of 2007 from 2.5-3% forecast range forecast in February.
The Fed’s preferred inflation gauge, the core personal consumption expenditure price index, which excludes food and energy, rose by 1.4% in 2Q from 2.4% in 1Q, well within the preferred Fed range of 1-2%. In the twelve months ending June, the measure rose by 1.9%, although the smallest increase in three years was not low enough to relieve concerns about inflation. Despite the widespread and deepening market turbulence, the Fed refrained from lowering the interest rate in early August repeating its concerns that inflation remained the predominant risk facing the economy. The downward revision in GDP growth in 2004-2006 by around 0.3% each year indicates that the productivity growth in the economy has been smaller and therefore the noninflationary growth potential lower than previously assumed, indicting that a pick up in the pace of growth could accelerate inflation. The Labor Department estimated that productivity advanced at an annual rate of 1.8% in 2Q from a revised 0.7% in the first quarter. At the same time labour costs rose faster than anticipated in 2Q. More recently, import prices rose by a 1.5% in July, from 0.9% in June, driven mainly by a 7% increase in petroleum import prices. On the employment front, first signs of weakening appeared in July as the rate of job creation slipped. Job growth slowed to 92,000 from 126,000 in June and the jobless rate rose to 4.6% from 4.5% in June. The Fed anticipates the jobless rate to be between 4.5%-4.75% in the fourth quarter. The rate had fallen to 4.4% in March, the lowest in more than 5 years. Moreover, initial jobless claims rose by a higher than expected 7,000 to 316,000 in the week ended Aug. 4. On the positive side, incomes continued to rise with average hourly earnings increasing more than 0.3% m/m in July for the third consecutive month. Retail sales increased 0.3% after a revised drop of 0.7% in June, indicating that consumer expenditure is not caving in. However, Auto sales in July fell to their lowest level in two years. Separately, the Institute of Supply Management’s report for the services industry indicated a deceleration in the rate of expansion. The index fell to 55.8 in July from 60.7 in June, the biggest drop in almost two years. A reading above 50 indicted expansion. Similarly, the July ISM manufacturing index fell to 53.8 from 56 in June. Overall, we now expect a growth of 1.9% for the whole of 2007, 0.1% lower than last month. At 2.6%, the forecast for 2008 is unchanged.
Preliminary official data indicate that the Japanese economy expanded at a lower-than-expected rate of 0.5% saar in the second quarter of 2007, a marked slowdown from the very rapid expansion of 3.2% during the first quarter. The slower GDP growth may dampen expectations for an interest rate rise in the next meeting of the Bank of Japan on August 23. However, even before the announcement of the GDP figures on Aug 13, this expectation had been shaken by the recent financial turbulence in bond and equity markets. The Bank of Japan joined the Fed and ECB in their efforts to respond to the looming credit crunch by injecting so far around a $13.6 bn into the banking system.
There are fears that the Japanese economy may be hit by a slowdown in the US in the wake of the housing sector tumult, since the US is Japan’s largest export market absorbing around 23% of Japan’s merchandise exports in 2006. Since domestic demand has not been very strong, the growth is mainly dependent on foreign demand. However, so far this year, export markets continued to be robust. The trade surplus surged by around 59% y-o-y in the first half of 2007 to $43bn as exports rose 12.8% while imports increased by 8.2% on strong demand for cars, semiconductors and steel.
Consumption remains the weak spot in the economy. Consumer sentiment deteriorated in June and July, after the government rolled back tax rebates. The Cabinet office monthly consumer confidence index fell to a two-year low of 44.4 in July from 45 in June and has not been above 50 since April 2006. Wages fell 0.7% in the second quarter from the previous quarter, despite a fall ion the unemployment rate to a nine-year low of 3.7%. Consumer spending rose by 0.4% from the previous three months, half the pace of the first quarter. Data released by the Ministry of Internal affairs indicate a small growth in average household spending of 0.1% in June, for the fifth consecutive monthly increase. The consumer price index continued to fall for a fifth month in a row dropping 0.2% in June. The GDP deflator in the second quarter also fell by 0.3% from the same period a year earlier, slightly lower than expectations.
Separately, a preliminary report on the Japanese leading indicator, a broad measure for the growth outlook, rose for the first time in eight months above the 50% threshold to reach 80%, signaling acceleration in economic growth in the coming months. In addition, industrial output rose a seasonally adjusted 1.2% in June, ending a three month period of decline, on the strength of oversees demand, especially from China and Europe. In contrast, core machinery orders, excluding shipping and electric utilities, widely regarded as a leading indicator of business investment, fell sharply by 10.4% in June from month earlier. It was the first fall in three months
and the biggest since July 2006. Overall, we expect the Japanese economy to expand at the rate of 2.6%, about 0.3% higher than last month’s forecast.
Most economic indicators continued to indicate robust expansion but growth in the second quarter may have softened somewhat from the first quarter. The economic expansion continues to be dependent on investment and exports at a time when the strength of the euro- reaching record highs against the dollar which may dampen export growth. The Bloomberg PMI index of retail sales shows a drop to a seasonally adjusted 46.2 in July from 48.2 in June, the third month the index was below 50 indicating a contraction. A combination of higher interest rates and increases in gasoline prices are seen to have hampered consumer expenditure. On the other hand, the service sector continued to grow briskly albeit at a slightly lower level than in June. The flash RBS/NTC Research Purchasing Managers’ Index (PMI) fell to 58.1 from the 12-month high of 58.3 in June. Similarly, manufacturing sector activity lost some momentum in July as shown by the as the PMI index for manufacturing which dipped to 17-month low of 54.8 in July from 55.6 in June, but still remained well above the 50 level which indicates no growth. However, the export orders sub-index at 54.4 was at its lowest level since August 2005, suggesting that the strong euro may be taking its toll, although exports continue to be robust due to strong global growth. While exports fell 1.2% m/m in May, 0.4% in April and were flat in March, the three quarter average was 7.4% higher y-o-y given the strong increase seen around the turn of the year.
In Germany, the largest Euro-zone economy, consumer confidence rose to an eight-year high as unemployment fell to its lowest level in 14 years, amidst strong wage growth. The Ifo business confidence survey showed some softening but was not far from record levels. The unemployment declined to the lowest level in 14 years to 9% from 9.1% in June second quarter GDP rose 0.5%, the same rate as the first quarter.
The ECB continues to see risks to stability due to mounting inflationary pressures in the eurozone. Capacity constraints, potentially higher wages given tighter labour markets, mounting corporate pricing-power, strong growth in money-supply and credit as well as elevated oil prices are seen to be pushing prices up. Second-quarter capacity utilization in the euro region rose to 84.8%, the highest level in more than 16 years, according to figures published by the Bundesbank. The money-supply growth in the euro-zone, which the bank uses as a gauge of future inflation, accelerated to close to the fastest pace in 24 years in June. M3 rose 10.9% from a
year earlier, after increasing 10.6% in May. The central bank left interest rates unchanged in its latest policy meeting in early August but hinted at another rate increase in September using the term “strong vigilance” to signal another rate increase, which has been widely expected. However, the recent turbulence in financial markets which has hit European banks as well as bond and equity markets may cause the bank to reconsider this early tightening. The ECB led other central banks in attempting to avoid a liquidity crisis and injected on three consecutive days over 200bn euros (€94.8bn euros on August 9, €62bn euros on August 10 and €47bn on
August 13), as the overnight euro rates rose well above the ECB’s benchmark rate of 4%.
Former Soviet Union
The economy in Russia grew faster-than-expected in the first half of 2007, driven mainly by strong investment growth of 7.8 %, according to official sources. Private capital inflow contributed to the investment boom and acceleration of imports. The Central Bank of Russia (CBR) estimated the net inflow of capital to the private sector in the first six months of 2007 to reach $70bn, compared with $40.9bn in 2006. Savings in Russia soared by 218 billion roubles in June 2007 and widened by 1.1 trillion roubles in the first half of this year, the Economic Development and Trade Ministry reported. Calculated from early 2002, the cumulative growth in savings reached 8.5 trillion roubles (nearly $350 billion, or roughly 35% of GDP). Russia’s oil and gas sector plans to raise investment by 25% (nearly 8% of GDP) this year and in 2008. Industrial production grew by 10.9% in June 2008, agricultural output by 2.7% in May 2007. Industrial output growth was led by manufacturing which was 15.6% higher this June than the same month of 2006. Inflation has picked up in the second quarter of 2007, the official figure in June is estimated in the range of 0.5-0.6% which might lead to overshoot the CBR target of 6.5%- 8.0% this year, mainly as a result of food price increases of 1.7% in June. Rising imports could reduce the trade surplus to a point that the CBR would not intervene to avoid rouble appreciation. In June the stabilization fund reached $121.68 billion.
In Kazakhstan GDP continued to grow robustly. The economy is relying on private consumption and investment for much of its momentum. Private credit growth, together with higher export revenues and potential pass-through from higher inflation in Russia, will add to the inflation pressure in Kazakhstan. The disinflation trend from last year lasted until April, but by June inflation had risen to 8.1% y-o-y.
China’s annual economic growth surged to an eleven-year high of 11.9% in the second quarter according to National Statistical Bureau (NSB) in China. The figures put China on course to keep on its straight fifth year of double-digit growth and to overtake Germany as the world’s thirdbiggest economy - perhaps as soon as this year. Some observers argue that the reported numbers may partly reflect a move to correct previous inaccuracies. Classic symptoms of overheating are absent. Bank lending and imports have slowed in recent years, and reports of surging wages due to labour shortages do not reflect reality and inflation is not bad as it seems. Excluding food, consumer prices have risen by only 1% over the past year. The People’s Bank of China (PBOC) on 21 July has raised the lending and deposit rates by 0.27 percentage points to 6.48% and 3.33%. However, rates are still low for such a fast-growing economy, but it is not widely expected that the PBOC will lift rates aggressively to address the current wave of inflation. It is more likely that the Central Bank will continue its gradual appreciation of the yuan which could bring down the cost of imported goods. The yuan’s appreciation is noticeably faster this year. It rose by an annual rate of 9% since April compared with only 3.4% in 2006. The rise of interest rate provides a useful signal of the government’s intention to slow down investment.
Investment in fixed assets such as factories and real estate was up 25.9% in the first half of the year; the trade surplus is setting successive monthly records; and retail sales in the first six months grew at the strongest rate since 1997. The authorities are likely to impose new curbs on investment in energy intensive and polluting sectors. The amount of energy consumed in China per 10,000 yuan of GDP decreased by 2.78% y-o-y, more than doubling the annual reduction of 2006, during the first quarter of this year, as reported by the NSB and National Development and Reform Commission. However, it was still below target. China’s state environment watchdog unveiled a new policy last month with the PBOC and the China Banking Regulatory Commission (CBR) that makes it much harder for heavy polluters to get bank loans. The new policy forbids banks to extend loans to new projects that have failed to pass environmental evaluations, and requires financial institutions to strictly control loans to companies that have failed to rectify excessive emissions from already-completed projects.
The Reserve Bank of India (RBI) released its quarterly review of the monetary situation last month, reiterating its concerns over inflationary pressures. It paused in its interest-rate raising cycle. The aggressive tightening cycle came as the RBI in effect to redress previous policies that were accommodative for too long causing an acceleration in inflation. While headline inflation has eased in line with the decline in global oil prices from peak levels, underlying demand pressures remain strong. Intensifying demand has been reflected in high rates of capacity utilisation, rising wage pressures and the widening trade deficit. Government officials in India are affirming that achieving 10% growth will be possible in 2008.
Brazil’s economy seems on track to grow by around 4% this year, given its performance during the first quarter. Economic output expanded by 4.3% y-o-y during the January-March period, driven primarily by the industrial and service sectors. Consumer spending and corporate investment were both strong. The reduction of inflation promoted lower interest rates and higher growth. In its latest loosening of monetary policy, the Brazilian Central Bank on 7 June reduced the benchmark Selic rate by half a percentage point to 12%, a record low. This followed a string of 16 rate cuts since September 2005, when the Selic stood at 19.75%. The resulting decline in borrowing costs has fuelled consumer demand for items such as appliances and cars, and boosted capital investment by companies. Argentina is expected to make a gradual transition from the high rates of growth that have characterised the rebound from the 2001-02 crisis to more sustainable rates of economic expansion. After growing for four consecutive years at around 9% per year, real output growth is expected to ease slightly in 2007 — our estimate is 7.5% — before slowing more noticeably in 2008. Private consumption has been growing at a brisk pace, aided by increases in employment and real earnings. Resurgence in inflation or a collapse in demand and prices for Argentina’s export commodities are the main downside risks to our GDP growth forecasts.
OPEC Member Countries
Growth prospects in OPEC remain robust, with overall GDP growth for the region forecast to average around 5.7% per year in 2007. In the past five years the dollar has fallen by about 20% against a broad index of currencies and by about 60% against the Euro. The weakening dollar has affected the economies of Member Countries in two ways. Firstly, it has decreased the purchasing power of the members. This loss of dollar purchasing power is affecting OPEC’s ability to conduct trade with its non-US partners. Much of its trade is with Europe is denominated in euros and pounds, which have rapidly risen in value against the dollar. Secondly, the weak dollar has caused a rise in inflation in some members. Pegging the local currencies to the dollar entailed that imported goods in other currencies rose in cost.
The Central Department of Statistics in Saudi Arabia reported early this month that inflation rose to a five-month high of 3.1% in June as food and housing costs climbed. The cost of living index rose to 104.4 points in June, up 0.2% compared with May. In Algeria the consumer price index (CPI) in the capital, Algiers — the typically-used measure of inflation for Algeria — rose by 2.6% y o-y in the first half of this year, according to Algeria’s National Statistics Office. The yearly increase in CPI can be traced to increases in the cost of foodstuff, which accounts for 44.01% of the basket of goods and services used in calculating the index, along with jumps in the cost of healthcare (up 2.7% y-o-y) and furniture (up 0.7%). The increase in the cost of foodstuffs was in turn due to a 3.7% y-o-y jump in the cost of fresh agricultural products.
Oil prices, the US dollar and inflation
The US currency resumed its downward trend in July falling against all its major counterparts. It lost most versus the pound Sterling (-2.34%) followed by the euro (-2.21%), the Swiss franc (-2%) and least against the yen (-0.84%). The euro averaged €1.3715 in July from €1.3418 in June while the yen averaged 121.6 from 122.6 in June. The pound sterling remained above $2/£ averaging 2.033 dollars over the month of July.
The dollar’s losses can be attributed to the continued and deepening fallout from the US subprime housing sector and the increasing risks this poses to the US economy. In early August, the dollar fell to the lowest level in four months against the yen of around 117 Y/$ and to near record levels versus the euro of over $1.38 on market speculation that the Fed may resort to an interest rate cut in the coming months, although the Fed’s appears to still be more worried about inflation
In July, the OPEC Reference Basket rose by almost $5/b or 7.46% to $71.75/b from $66.77/b in June. In real terms (base July 1990=100), after accounting for inflation and currency fluctuations, the Basket price rose by almost $2.38/b or 5.45% to $46.01 from $43.63.