United States of America
The prospects for the US economy are shadowed by the deepening woes in the subprime credit sector and the possible spillovers on economic activity. Financial markets remain on edge despite the massive injections of liquidity in the early part of August followed by a drop of 0.5% in theUS discount rate mid-month. Attention is gradually focusing on the possible spillovers from the credit crisis on growth in the US and globally. However, it is too soon to gauge the effects. On the ground, the recent US indicators paint a picture of a slowing but still moderately expanding economy. There was an upward revision in 2nd quarter GDP growth to a seasonally adjusted annualized rate of 4.0% from 3.4% reflecting upward revisions to exports, nonresidential structures, equipment and software investment, and a downward revision to imports. Residential fixed investment was revised downwards and deducted 0.6 percentage points from growth in Q2.
The situation in the housing sector is expected to worsen before getting better. Mortgage delinquencies and foreclosures are on the rise, particularly for subprime mortgages but a slight increase is also seen for prime mortgages. The S&P/Case-Shiller national index shows home prices falling in July to 184 from the peak of 190 reached last June 2006 (March 2000=100). The index has fallen every month this year. Pending home sales in July, a leading indictor of existing home sales, dropped 12.2% m/m, the largest decline since the series started in 2001, reversing a gain of 5% in June. In its latest forecast, the National Association of Realtors predicts that US existing home sales will fall 8.6% in 2007, higher than its 6.8% estimate a month ago. Newhome sales are seen to decline 24% after an 18% drop in 2006. With the inventory of unsold existing homes rising to 9.6 months in July, home construction activity is expected to remain depressed in the coming months until inventories drop. In July construction activity fell 0.4%.
On the employment front, the August report brought little relief. Payrolls fell by 4000 in August contrary to market expectation of a rise of 100,000 jobs. The unemployment rate, however, remained unchanged at 4.6% but is expected to rise to perhaps 4.8-4.9% by year-end. The employment report increased the probability of an interest rate cut by the Fed on September 18 by at least 25 basis points, particularly since the downward trend in core inflation was maintained in July. The preliminary consumer confidence index to August 22 dropped sharply to 105 from a six-year high of 111.9 in July, with the expectations index declining to 88.2 from 94.4, an early indication that consumers are unsettled. The drop in confidence was attributed to subprime housing woes and volatility in financial markets. It remains to be seen whether this will dent consumer expenditure, which had already moderated in Q2. Retail sales increased 2.9% inAugust according to the International Council of Shopping Centers based on results from 47 retailers. Sales of big ticket items have been receding in the last months but data for August show a slight improvement in auto sales helped by incentives. Annualized sales of cars and light trucks in August rose above the 16mn mark for the first time since May 2007While unchanged from August 2006 sales were much improved from the 12% decline in July. On the positive side one also notes the upwardly revised figures for worker productivity in the second quarter and the 0.5% rise in personal income in July. Nominal disposable income rose by 0.6%, while real disposable income rose 0.5%.
Measures of economic activity such as the ISM manufacturing index in August show a drop to 52.9 from 53.8 in July, indicating some slowdown in activity, but not a breakdown. More positively, the ISM services index remained unchanged at 55.8, indicating a continued expansion in the services sectors, which represent the bulk of economic activity and employment. Moreover, the Fed Beige Book which includes anecdotal information about regional developments within the US indicated that the fallout from the subprime sector was so far modest. Turning to the external sector, the slight narrowing of the trade deficit in July, despite a higher oil bill, indicates that the external sector, assisted by strong global demand and a falling dollar, could remain a main support for the economy in the third quarter. Overall, growth is seen at 1.9% in 2007 and 2.6% in 2008, unchanged for the moment from last month’s forecast.
Revisions to second quarter GDP reveal that the Japanese economy contracted at a 1.2% annual pace (-0.3 q/q) from an original estimate of 0.5% annual growth, on a sharp slowdown in private capital expenditure- which fell 4.8% in annualised terms almost completely reverting initial estimates of growth of 4.9%. The downward revision cast doubt on the durability of the economic recovery. However, data for Japanese GDP tends to be very volatile, in particular those on investment. The government sees the drop in the second quarter as temporary and growth is forecast to pick up in the second half of the year. The negative GDP report and the turbulence in financial markets, with Japanese equity markets badly hit, has led the Bank of Japan to postpone monetary tightening in August.
More recent July indicators reveal a mixed picture of the economy, which appears to be passing through a temporary weak spot making it potentially vulnerable to a slowdown in the US, especially after the strong yen appreciation resulting from the unwinding of the carry trade and the general increase in risk averseness. However, the export sector remains very competitive, and exports to other destinations apart from the US are expected to remain strong.
Despite a drop in the unemployment rate to a nine-year low of 3.6% in July, 0.1% lower than June, consumer demand remains anemic and deflation persists. Average household spending declined by 1.2% m/m. or 0.1% lower in real terms from the corresponding period of 2006, marking the first decline in seven months. Seasonally adjusted retail sales dropped 2.4% in July, affected by cold weather. The consumer price index has fallen for six consecutive months, dropping by 0.1% in July from year earlier level. Wage growth has continued to lag behind improvements in the labour market.
Separately, core machinery orders rose a seasonally adjusted 17% to 1.12 trillion yen ($9.9 billion) from June, led by demand for electronic machinery, representing the largest in crease in almost four years. The forward looking indicator points to strong capital expenditure in the months ahead. Industrial output declined by 0.4% from the previous month in July, reflecting the interruption to production caused by an earthquake in the month. Industrial output growth has slowed in four of the past five consecutive months but is forecast to improve in the third and fourth quarters.
The Japanese current account rose to a fresh record high of $16.3bn in July, or 4.6% higher than the corresponding month in 2006. The trade surplus in contrast contracted by 21.1% from year earlier level to $5.9bn. This was the first drop since January. Exports of goods rose by 11.1% while imports expanded by 16.6%. Exports to the US rose by only 1.3%, a fifth of the pace in June, feeding fears about the dampening effect of the US housing sector decline on demand for Japanese cars and other goods. However exports growth to the EU and China also slowed. Overall, we expect the Japanese economy to expand at the rate of 2.4% in 2007 0.2%, lower than last month’s forecast, as a result of the decline in the second quarter. The forecast is unchanged for 2008 at 2.2%
Growth in the Euro-zone in the second quarter softened considerably to 0.3% q/q from the robust 0.7% q/q rate achieved in the first quarter. A marked slowdown in fixed investment in the second quarter was caused by a slowdown in construction. The pace of expansion may pick up in the second half of the year, but will probably not achieve the peak levels witnessed in the fourth quarter of 2006, when it reached 0.9% q/q, in particular since the financial market turmoil is expected to take its toll on growth. The European Commission has lowered its forecast for Eurozone growth to 2.5% for 2007, or 0.1% lower than its May forecast. The European Central Bank continued to add liquidity to the credit markets (e.g. €42.2 bn on September 6) to lower the rising overnight deposit rates. The ECB also left interest rates unchanged on September 6 due to fears that the US housing slump may pose a threat to economic growth, even though activity has not been affected as yet. However, confidence has suffered. An index of sentiment among executives and consumers in the Euro-zone issued by the European Commission fell to 110 from 111 in July
On the other hand, the Euro-zone services and manufacturing PMI surveys moved downwards but were still consistent with a moderate pace of growth. The Royal Bank of Scotland Group Plc manufacturing index fell to 54.3 in August from 54.9 in July, the lowest reading since January 2006. However it remained well above 50 and consistent with industrial growth of around 3% q-o-q. Manufacturing orders grew at the slowest pace since November 2005 as demand at home and abroad declined. The services index dropped to 58.0in August from 58.3 in July, indicating continued strong expansion in service activity at a higher level than in the first half of the year.
Inflation also remained at 1.8% in August, below the ECB target of 2% for the twelfth month in a row. But inflation may pick up in coming months if consumer spending rises, supported by thehigh employment levels. The jobless rate was at a record-low of 6.9% in July.
All three major economies in the euro region — namely Germany, France and Italy — suffered a slowdown in the second quarter. In Germany, the largest economy in the Euro-zone growth which has been very strong so far, moderated to 0.3% in the second quarter from 0.5% in the first quarter and 0.8-1.2% q/q throughout 2006. The softer growth in Germany can partly be attributed to the negative effects on consumer expenditure of the 3% VAT tax introduced in January. Moreover, the construction sector witnessed a contraction in the second quarter following the very strong expansion in the first quarter due to unusually mild winter weather. However, Germany continued to benefit in the second quarter from robust net trade and healthy spending on capital equipment. In July, moreover, consumer confidence rose to an eight-year high as unemployment fell to its lowest level in 14 years, amidst strong wage growth. However, the key Ifo survey of 7,000 German businesses fell in August, the third month of declines. Although the current conditions component remains high by historical standards, confident about future prospects has diminished. Manufacturing orders also dropped sharply in July. Orders fell 7.1% from June, representing the biggest drop in sixteen years. It aroused fears that the German economy, which had been a motor of growth for the euro-zone would slow down.
Overall, the forecast for the euro-zone remains unchanged from last month at 2.6% in 2007 and 2.4% in 2008.
Former Soviet Union
Russia’s state statistics agency said the country’s GDP grew 7.9% in the first half of 2007. It was earlier reported that the growth rate was 7.9% y-o-y in January-March, and 7.8% in April-June, against 5% and 7% respectively in the same periods of 2006. In addition, industrial production grew 7.7 % within the first seven months of 2007, with the secondary industry expanding at an even faster rate. Retail trade added 14.4 %, imports 37 % and investment grew 22.7 %. Real personal incomes climbed 11.9 %, while real wages increased 17.1 %. In January-August, inflation amounted to 6.7 %, compared with 7.1 % during the same period a year earlier. Investments have been picking up over the year — predominantly in the manufacturing and construction sectors. The public sector is also helping to support growth ahead of parliamentary (2 December 2007) and presidential (9 March 2008) elections.
Economic growth in all countries of the Commonwealth of Independent States (CIS) is exceeding all recent forecasts of the International Monetary Fund (IMF). The CIS countries’ statistics committee reports that over the first six months of the year GDP grew by 35.1% in Azerbaijan, by 10.6% in Kazakhstan, and 7.8% in Russia. IMF reports rapid growth of economic activity reflecting substantial development indicators in countries exporting energy resources and a certain rise in activity in countries importing them. But high GDP growth conceals fundamental problems facing Russia and other “raw material tigers” of the CIS countries. The growth of investment in the engineering sector is remaining at 2-3%, which is not enough for bridging the technological gap with industrialized nations.
China’s inflation hit its highest rate in almost 11 years in August while the nation’s trade surplus soared again, official data showed, signaling more interest rate hikes ahead. The Chinese government is expected to act following the August data despite already raising interest rates four times this year as part of a package of measures aimed at slowing the nation’s economy. Consumer prices rose 6.5% in August from a year earlier after gaining 5.6% in July, the National Statistics Bureau reported. The trade gap widened 33% to $24.97 billion, the second-highest monthly total. The August inflation figure was fuelled in part by an 18.2% rise in food prices, including a 49% surge in the cost of meat. Meat prices are a key concern for Chinese families, who on average spend about one third of their income on food.
India’s GDP growth quickened last quarter to 9.3% on the back of double-digit increases in industries like manufacturing and services. Sectors that saw “significant growth” included manufacturing at 11.9%, construction at 10.7%, financial services and real estate at 11% and agriculture at 3.8%, according to India’s statistical organization. Agriculture, which is weighed significantly in the index and accounts for two-thirds of the livelihoods of India’s population, saw a boost on the back of a good wheat harvest. In its annual outlook report, the Reserve Bank ofIndia said its monetary policy would focus on sustaining the growth momentum while keeping inflation under control. The bank’s medium-term inflation ceiling is set at 5%. Government figures showed that inflation had dropped below 4% to 3.94%. An abundance of foreign fund flows had made liquidity management a key concern for the Reverse Bank of India (RBI). But in recent weeks, the subprime crisis has resulted in money flowing out of the Indian markets. On the domestic front, the outlook remains strong. India’s 300 million-strong middle class is spending more on goods driving up demand across sectors.
In the first quarter of 2007, Brazil’s GDP grew 4.3% from the year-earlier period, as falling domestic interest rates and expanding credit led to strong performance in the services sector. The inflation projection remains below the central bank’s inflation target of 4.5% for the year. The IPCA inflation rate reached 3.74% for the 12 months through July, according to data from the Brazilian Census Bureau.
OPEC Member Countries
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 (ONS). 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. Also according to Algeria’s National Data Processing and Statistics Centre (CNIS), the country’s merchandise-trade surplus stood at $14.3 billion in the first half of 2007, as opposed to $17.7 billion a year earlier. Imports, which grew moderately in 2006, have risen rapidly thus far this year. Meanwhile, export growth is expected to ease this year, although the trade surplus will be strong. The surplus as a share of GDP will, however, be smaller than a year earlier. It is worth pointing out that China has become Algeria’s second trading partner, ahead of the USA, Germany, and Spain.
In Indonesia, investment continued to rebound in August, according to data released by the National Investment Coordinating Board (BKPM) this month. Combined actual domestic and foreign direct investment (FDI) surged by 123% on the year to $11.70 billion in the first eight months of 2007. Concurrently, domestic investment soared by 171.9% to $3.57 billion. The sectors attracting the most investment included paper and printing and the chemical and pharmaceutical industries. The Indonesian government has announced an increase in budget spending in 2008, which would support acceleration in growth.
Oil prices, the US dollar and inflation
The US currency continued to rise against the euro and the pound sterling but at a slower pace than in the previous month, while falling sharply versus the yen and slightly versus the Swiss franc, as the carry trade in the latter two currencies began to unfold. The dollar fell by 4% versus the yen and by 0.5% against the Swiss franc. It appreciated by 0.68% against the euro and by 1.19% versus the pound sterling.
However, starting from mid July the dollar started to fall versus the euro, a depreciation which continued into the first two weeks of August, when the US currency fell to record lows versus the euro on September 12 of $1.3889, compared to a previous low of $1.3852 on July 24. The dollar’s losses against the euro can be attributed to an expectation of lower interest rates in the US. The weakness versus the yen is also a result of the financial turmoil with the reversal of yen carry trade. The yen stood at around 114 Y/$ on September 11. Against the yen, the US currency has fallen almost 8% from its highest point this year reached January 12.
In August, the OPEC Reference Basket fell by $3.1/b or 4.3% to $68.64/b from $71.75/b in July. In real terms (base June 2001=100), after accounting for inflation and currency fluctuations, the Basket price fell by almost $2.5/b or 5.1% to $47.49 from $50.04. The dollar depreciated by 0.43% as measured against the import-weighted modified Geneva I +US dollar basket.