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Industrialised countries
United States of America
A spate of negative economic data for December has increased fears that the US economy will slide into recession in 2008. In particular, the unexpectedly sharp monthly increase of 0.3 percentage points in the unemployment rate, as well as the drop in manufacturing output, as seen from the drop in the PMI index for manufacturing below the 50 mark, have, in combination with deepening slump in housing, been interpreted by many observers as signs of an impending recession. The unemployment rate has risen from a historically low 4.4% in March 2006 to 5.0% in December 2007 and such a surge of more than 0.5 percentage points rise has been seen in the past as presaging recession, technically defined as two consecutive quarters of negative growth. In December, employers added only 18,000 workers, the lowest gain since 2004. However, seen over the whole year, the labour market has been relatively tight and caution is needed not to over interpret one month’s extremely negative data. Nevertheless, the decline in manufacturing is an alarming signal in addition to the message from the Conference Board’s index of leading economic indicators which continued to drop in December (by 0.2%) for the third consecutive month.
Moreover, the 0.4% drop in retail sales in December after a downwardly revised rise of 1% in November added fuel to the view that the risk to growth are intensifying, although the early Thanksgiving may have inflated the November figures at the cost of December sales. Retail sales account for around 50% of consumer expenditure, which in turn is responsible for more that 70% of GDP. The drop in the December sales was led by a large 2.9% decline in building-material stores, the biggest since February 2003, mirroring the housing sector recession. Sales of gasoline also fell reflecting a drop in prices — $3.01/gallon for regular gasoline versus 3.07/gallon in November. For all of 2007, retailers posted a 4.2% increase in sales which was the smallest rise in five years. In 2006, retail sales rose by 5.9%. On the other hand, the preliminary Reuters/University of Michigan index of consumer sentiment in January surprisingly climbed to 80.5 from December's 75.5 reading which was the lowest since 2005. The improved sentiment is attributed in part to lower gasoline prices.
However, many forecasters continue to see the US economy avoiding recession and growing in the first half of the year at very low rates to gradually recover in the second half of the year. The optimistic camp see the economy receiving further support from continued strong growth in exports, helped by the falling dollar, as well as further monetary easing. Moreover, the US administration proposed on 19 January a temporary fiscal stimulus package of up to $150 bn (around 1% of GDP) which would include corporate investment incentives and personal tax rebates expected to create about half a million new jobs. Such an initiative had been widely discussed and the principal has received Fed support. This would be over and above steps already envisaged to help homeowners avert foreclosure.
Headline consumer price index was 4.1% in December slightly lower than the 4.3% in November but core CPI, excluding food and energy rose to 2.4% from 2.3%. However, the Fed is worried enough about growth to temporarily ignore these inflationary signals. It has indicated readiness to respond aggressively to the deteriorating economic climate and it is now widely expected that the fed will cut the target federal funds rate by 0.5% end-January and may be follow with further easing in the coming months. The Fed’s regional business survey “Beige Book” released mid- January confirmed that the economy had slowed down in late November and December, with districts reporting disappointing holiday sales.
The housing sector recession deepened. Housing starts fell 14% in December to an annual rate of 1.006 mn, the lowest level since 1991. For all of 2007, housing starts were down 25% over the previous year to 1.354 mn, registering the biggest decline since 1980. The beginning of construction on residential units is an important predictor of consumer purchasing on furniture and appliances. Moreover, building permits declined by 8.1%, bringing 2007's decline to 25%, the biggest since 1974 and indicating that future construction growth will be low. Moreover, the demand for housing may be depressed by the increasing difficulties faced in obtaining mortgages. The Fed has drawn attention to the mounting evidence of more restrictive lending practices by banks to households as well as firms.
The overall forecast for the US economic growth in 2008 has been revised down by 0.2 percentage points to 1.8%, with an expectation of little to no growth in the first quarter.
Japan
The Japanese economy is set to slow down in 2008 as business sentiment, particularly that of small firms — which employ the bulk of the labour force (around 70%) - has deteriorated and consumer spending continues to be hampered by rising prices and stagnant wages. The prospects for exports have also been scaled down, on large part due to the economic slowdown in the US. The Economy Watchers survey diffusion index fell to 36.6 in December, the lowest level encountered since May 2003. All three components of the index — households, businesses and employment — deteriorated. The Nikkei 225 Stock Average tumbled 9.5% in the first 10 trading days of 2008. It increasingly appears that not only the US but also the Japanese economy is seen to be threatened by recession in 2008.
Both consumers and businesses are concerned about price increases from commodities including energy prices. A survey conducted by the Bank of Japan survey revealed that consumers in the last quarter of 2007 had became the most pessimistic about the economy since March 2003. Some 86% of respondents predicted prices would rise in 2008, the highest proportion since the central bank initiated surveys on inflation expectations in 1997. Moreover, the consumer confidence index, which measures sentiment of households of two people or more, fell to 38 in December from 39.8 in November, its lowest level in more than four years. A reading below 50 signals that pessimists outnumber optimists. This is seen as a signal that households may scale down spending as higher prices and falling wages erode spending power. Prices of more than half of the 523 goods in the consumer price index rose in November while wages stagnated. Revised Labor Ministry data show that wages gained 0.1% percent in November from a year earlier, after falling in the previous two months.
However, consumers’ perception of inflation is mush higher than reality. Consumers believe prices will rise by 7.3% in 2008. In contrast, most forecasters see that Japanese economy, which has long suffered from deflation, may experience only around 0.3-0.6% consumer price inflation in 2008. In November, the latest month for which figures are available, overall consumer prices fell by 0.2% from October but rose 0.6% from previous year. Fuel, light and water charges rose 0.9% on the month and 2.2% on the year. The December increase was only the second monthly rise in 2007. Consumer pessimism and lackluster demand may affect consumer behavior and hinder companies from passing on higher costs to consumers, a factor which is weighing on small firms and also affecting the ability to raise wages. Wholesale price inflation figures which accelerated in December and were higher than consumer price inflation confirm this view. Profits at small and midsized companies fell in the third quarter for the second time in five years. Moreover, bankruptcies rose to a four-year high in 2007 in part due to the housing slump and
higher energy and raw materials costs. Small and midsized enterprises accounted for more than 99% of the national bankruptcy figures.
Meanwhile, machinery orders fell 1.7% in November m-o-m as companies cut spending in expectation that the US slowdown may spillover into Asia and hurt exports. Investment outlays were a main contributor to economic expansion in the previous fiscal year. Private sector orders, excluding volatile elements (ships and power), fell by 2.8% from 12.7% in the previous month. Although it is expected that prospects for exports will worsen, particularly due to the economic slowdown in the US, the current account surplus widened 2.1% in November with exports to China and other emerging markets compensating for slowing U.S. demand. China is now Japan's largest trading partner. Overall, Japanese economic growth was revised down 0.2 pp for 2008 to 1.5%.
Euro-zone
Third quarter euro-zone economic growth was revised up to 0.8% from previous quarter or 2.7% from year ago, from an initial estimate of 0.7% quarterly growth or 2.5% y-o-y. However, recent indictors point to a slowdown in the fourth quarter and prospects for 2008 have declined. In particular, exports growth is threatened by an ever stronger euro. The single currency has risen 13% against the dollar in the last 12 months, reducing euro-zone competitiveness. However, on the positive side one notes the continued improvement in labour markets. The unemployment rate fell to 7.2% in November, the lowest since data were first collated in 1993.
Both the PMI manufacturing and non-manufacturing indices declined further in December but remained above the threshold 50 mark, indicating continued albeit slower economic expansion. The Royal Bank of Scotland Group Plc's manufacturing index fell slightly to 52.6 from 52.8 in November. The euro-zone service industries grew at the slowest pace in two and a half years in December, when the purchasing managers’ index for services fell to 53.1, the lowest since June 2005, from 54.1 in November. Services growth moderated in France and fell sharply in Germany, to 51.2 from 53.1 in November, while in Italy sales were reported to have declined. The European Commission’s economic sentiment index for the Euro-zone retreated to 104.7 in December, from 104.8 in November and from a peak of 112.1 in May. While both business and consumer sentiment have declined the overall index is still well above its long term average of 100.
Moreover, industrial production in the eurozone fell by 0.5% but rose 2.7% from previous year level. In Germany and France, year on year industrial production slowed sharply in November-- to 3.5% and 2.5% from 6.4% and 4.2%, respectively. Other signs of weakness included the eurozone retail sales in November, which contracted by 1.1% y-o-y, the largest decline for ten years. In Germany, sales fell even more- by 3.1% y-o-y, partly reflecting the previous year’s VAT hike. Despite a further rise of 12.3% in the M3 money supply in November (y-o-y), used by the ECB as a gauge for inflation, and continued higher consumer prices—the CPI rose by 3.1% y-o-y in November and December, the highest rates in more than six years, and well above the target of 2%, the ECB left euro-zone interest rates unchanged at 4% at its meeting on December 10. Core inflation, excluding energy, food, alcohol and tobacco, was up 1.9% y-o-y in December. The central bank has postponed plans to raise interest rates since September after the collapse of the US subprime mortgage markets also had repercussions on European banks and credit markets. The ECB continued to inject large sums into the banking system in December in an attempt to ease liquidity. However, the ECB hinted that it would move on interest rates if an inflationary spiral where to materialise. The central bank is worried about the round of wage bargaining in France and Germany. For 2008, the ECB h raised its inflation forecast to about 2.5% from 2%. It is expected that euro-zone inflation will remain above 3% in the first quarter of 2008. Overall, our forecast 2008 for the Euro-zone growth has been revised down slightly to 1.9% in 2008.
Former Soviet Union
The Federal State Statistics Service (Rosstat) in Russia reported early this month that inflation stood at 11.9% in 2007. Inflation reached 1.1% in December against 0.8% in the same month of 2006. Russia’s core inflation amounted to 11% in 2007 and 0.9% in December 2007. Compared with the central bank’s 7-8% target for 2007, inflation has risen to the mentioned levels mainly reflecting soaring food prices. Even excluding food prices, inflation exceeded the target while real wages continue to grow by about 20% at a time when productivity growth is slowing. Growth of money supply is fuelled by the Russian central bank’s reluctance to allow the rouble to appreciate. Public spending according to the three-year budget for 2008-2010 is expected to increase over the next two years by 2½ percentage points of gross domestic product. On that basis, the International Monetary Fund estimates that Russia's budget, which was in surplus by more than 7% of GDP in 2006, will be approximately in balance by 2009.
Over the first ten months of last year, the Ukrainian economy was expected to grow by 7.3% y-o-y; strong performance in domestic trade, manufacturing and transport compensated the shortfall in agriculture. Ukrainian economy’s resilience to an energy price rise in 2006 and 2007 is a sign of a positive GDP growth in 2008. The benign external environment helped to achieve such growth (high world prices of steel and chemical products, robust growth in trading partner countries), buoyant consumption supported by loose income policy and a continuing credit boom, and a pass-through of rising energy prices to producers and consumers. The positive outlook is shaded by the surge of consumer inflation. CPI rose 14.8% y-o-y in October 2007.
Developing Countries
China is targeting 8% economic growth in 2008, compared with an estimated 11.5% last year, and expects its tightening measures will finally start having an effect by the second half of the year. Inflation remains a major challenge, and Beijing will work to strictly control it this year. Last year the People's Bank of China raised interest rates six times and ordered banks to raise their reserves ten times, but inflation, investment, gross domestic product growth and the money supply all have kept rising rapidly. Furthermore, China’s central bank said it will take more steps this year to cool inflation and prevent the world’s fastest growing major economy from overheating. China's trade surplus narrowed for the second month as export growth slowed. The surplus for December shrank to $22.7 bn from $26.2 bn in November, the Chinese customs bureau reported. Exports grew at the slowest pace in two years, indicating that recent yuan gains, the cooling global expansion and cuts to export-tax rebates on polluting industries are affecting exports.
Industrial production in India slowed in November making it more likely that the central bank may soon end more than three years of interest rate increases. The Reserve Bank of India has raised interest rates nine times since 2004 and ordered commercial lenders to set aside more funds as reserves five times in the past year to contain inflation below its target of 5%. Continued rapid growth in India pushed domestic demand higher and is fuelling the rapid expansion in imports. Spending on non-oil imports has risen faster than spending on oil imports, which suggests that record-high oil prices are not the sole factor behind the burgeoning import bill. The stronger rupee has hit the competitiveness of Indian exporters, the local currency has risen by more than 15% against the US dollar since October 2006, and labour-intensive export-oriented industries such as textiles and handicrafts have been hit hardest. China has become India's biggest trade partner surpassing US; India-China bilateral trade reached $38.6 bn in the calendar year 2007. During this period, India-US bilateral trade was just $34.6 bn.
Latin America is expected to see another good year in terms of macro-economic stability. The GDP is set to grow at relatively high rate, while inflation remains at overall manageable levels. Latin America’s inflation rate this year will be higher than the world average of 3.6%, the rates for the United States and the European Union and regions like developing Asia and Eastern Europe, but lower than in Africa and the Middle East. In its quarterly inflation report the Central Bank of Brazil expected the economy to expand by 5.2% in 2007. Brazilian GDP expanded by 5.7% in the third quarter from the same period of 2006. For 2008, the bank forecast GDP expansion of 4.5%. The report said faster economic expansion and a surge in consumer demand have increased inflation pressures and monetary policy needs to be particularly cautious to keep short-term price pressures from spreading. As a result, this could prompt the Brazilian central bank to maintain its benchmark “Selic” interest rate of 11.25% instead of lowering it in order to prevent the economy from overheating and causing more severe price hikes. The Selic was raised to 19.75% in mid-2005 to tame inflation, and the Central Bank then began lowering rates as the price increases eased. Successive rate reductions stopped in October, when the bank again started expressing concern about inflation. Argentina’s official statistics agency INDEC reported that inflation in Argentina rose 8.5% in 2007. The economy is heading into its fifth straight year of growth, helped by a currency devaluation in 2002 that strengthened industries, making local goods cheaper in international markets. A drop in unemployment levels to a 15-year low has helped boost consumers’ purchasing power, increasing demand for goods.
OPEC Member Countries
All OPEC members grew at healthy rates in 2007. Inflation posed the major economic problem for most of them. The six Gulf Arab states are expected to sustain an economic boom on the back of robust oil prices, but the weak US dollar could pose inflationary and exchange rate pressures on the region, the Institute of International Finance (IIF) forecast in a recent report. Statistics released recently show that Saudi Arabia’s inflation hit a new high in December, rising half a point on the previous month to 6.5%, driven by rising rent and food prices. The figures will add to pressure on the government to tackle rising prices and will keep alive the debate on whether the authorities will consider revaluing the riyal. Despite the fact that Angola’s rate of inflation in 2007 totaled 11.78%, the lowest over the last 16 years, as Angola’s National Statistics Institute (INE) announced, the accumulated inflation was still 1.78% points above the 10% projected in the Angolan State Budget for 2007, for the second consecutive year.
Oil prices, the US dollar and inflation
The US dollar staged a temporary partial recovery against all major currencies in December. It appreciated most versus the pound sterling rising 2.5%, while gaining 1.3% versus the Swiss franc, 1.0% against the Japanese yen and 0.8% vis-a-vis the euro.
The dollar’s breathing spell in December was based on the assumption that the Fed would not rush to lower interest rates again as inflation accelerated in the US. However, the recovery as short-lived. With increasing fears of a recession in the US, the prospects of a rate cut returned, and the dollar tumbled in the second week of January to near record lows versus the euro, while reaching 2 ½ year lows versus the yen and all time lows against the Swiss franc. By 15 January, the dollar had touched intra-day levels of ¥105.97/$, $1.4922/€ and an all-time low of Swiss Fr1.0838/$.
In December, the OPEC Reference Basket fell by $2.0/b or about 1.8% to $87.19/b from $88.99/b in November. In real terms (base June 2001=100), after accounting for inflation and currency fluctuations, the Basket price dropped $1.5/b or nearly 0.9% to $58.25/b from $59.14/b. The dollar appreciated by 0.7% as measured against the import-weighted modified Geneva I+US dollar basket, while inflation eroded the value of the barrel by 0.2%.
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