Mixed data in early 2007 suggest moderating growth in the US economy, despite warnings byformer Fed Chairman that the US economy has a one-in-three chance of falling into recessionin 2007. Following the stock market turmoil, the Fed was quick to reassure markets that theunderlying economy was sound and that its forecast for 2.5-3% growth in 2007 wasunchanged. However, the Fed identified the depressed housing market as the greatest risk tothe benign soft-landing scenario. Housing worries continue undiminished, with new homesales plunging by 16.6% m-o-m in January. Moreover, problems in the sub-prime mortgagemarket — where risky borrowers are given loans with little collateral — have escalated, asdefaults rose to four-year-highs in the fourth quarter. This segment is estimated to account for13% of the $10 trillion in home loans outstanding and represented a 35% share of themortgage securities issued last year, up from 13% in 2003. A report from the MortgageBankers Association also shows that foreclosures on all types of US home loans rose to recordhighs during the fourth quarter, indicating that the trouble in the mortgage market is notconfined to the riskier borrowers. The looming crisis in mortgage lending is exerting furtherdownward pressure on share prices and there is the risk that it may lead to a credit crunch.
Adverse weather conditions in February, the coldest February since 1994, have contributed tothe slowdown observed during the month in retail sales, employment and the growth in theservices sector. Despite income gains, retail sales in February were lower than expected, risingby a meager 0.1% following no change in January. Sales excluding motor vehicles andgasoline declined 0.3%, the largest drop in almost three years. The figures point to a gradualslowdown in consumer spending which has been the mainstay of the economy. On the otherhand, the Institute for Supply Management’s report showed the index for services falling to54.3 in February, lower than January’s reading of 59.0, but still above the 50 mark, indicatingthat US service industries continue to grow, albeit at a more moderate pace. The employmentreport showed that the economy generated 97,000 new jobs in February, below the 189,000average prevailing last year but in line with expectations. The rate of unemployment fell to4.5% from 4.6% in January, essentially unchanged. Adverse weather may have affected thereading for both services and employment.
Fourth quarter GDP was revised down from an advance estimate of 3.5% to 2.2% following 2%growth in the third quarter. The inventory correction, which subtracted 1.35 percentage points fromgrowth in the fourth quarter, is still underway. Business inventories rose 0.2% in January as salesdeclined by the most in four months. This indicates that orders to factories in coming months maybe weaker. Durable goods orders in January fell by 7.8% after a December rise of 2.8%. Inparticular, orders for non-defense capital goods excluding aircraft, a forward indicator of futurebusiness investment, fell by 6%, the biggest decrease since January 2004. However, the Purchasingmanagers index for manufacturing rose in January indicating some improvement in themanufacturing sector. The index of leading indicators rose slightly in January by 0.1% for thesecond month in a row. Positive contributions were made by the money supply index of consumerexpectation, average initial weekly claims for unemployment and stock prices.
The consumer price index in January rose by 2.1% from the same month in 2006. However,core inflation, excluding energy and food, increased faster at 2.7%. As the economy slowsdown, there are indications that the tightening monetary cycle in the US has reached its end,with rates unchanged at 5.25% since July 2006. Meanwhile, productivity gains slowed downand unit labour costs rose at a year-on-year rate of 3.4% in the fourth quarter, versus 1.5% ayear earlier. It is expected that wage increases will start to catch up with the boom in corporateprofits witnessed in the last five years. This could assist flagging private consumption growthbut may also add upward pressure on prices. Overall, the early 2007 indicators point tomoderating momentum in the economy which is expected to achieve a soft-landing growthrate of 2.4%, with the Fed seeing a possibility of strengthening towards the middle of the year.
Real GDP growth in the fourth quarter was revised upwards to 1.3% q-o-q or 5.5% at anannualized rate from 4.8% initially reported. This was in line with higher growth in privatecapital expenditures, which was revised up from 0.3% to 0.5% growth q-o-q. The growth inthe fourth quarter was the fastest in three years, and indicates that the economic recovery hasgained momentum. Recent data releases support this view with early indicators showingJapanese domestic demand growing strongly in the first quarter of 2007. The Cabinet Offices’Composite index, which is seen as a predictor of GDP growth, shows that both privateconsumption and business capital spending rose strongly in January, continuing the trendobserved in the fourth quarter of 2006. The average amount of monthly consumptionexpenditures per household (two or more persons) in January rose 0.6% in both nominal andreal terms from the previous year. The main increases were in clothing and footwear whileexpenditures on fuel, light and water charges fell by 7.1% in nominal terms and 8.0% in realterms. Moreover, the average amount of monthly income per worker’s household increased by0.7% in both nominal and real terms from the previous year. The average propensity toconsume was unchanged at 87.8% from previous month. Labour markets remained tight withthe number of unemployed persons reaching 2.64 mn in January, representing a decrease of280 thousand or 9.6% from the previous year. The unemployment rate, seasonally adjusted,was reported at 4.0%, unchanged from the previous month.
On the positive side one also notes that core machinery orders (excluding volatile shipbuildingand electric power companies), a leading indicator for capital expenditure rose a seasonallyadjusted 3.9% in January from 2% in the last quarter of 2006, indicating that the momentumin capital expenditure will be maintained in the first quarter. Separately, the consumerconfidence index rose in February to 48.4 from 48.1 in January and 45.9 in December,depicting in particular improvements in the employment and income parts of the survey.Consumer price inflation fell down to zero in January raising doubts about the end of thedeflationary pressures that had plagued Japan in the last years. Nevertheless, the Bank ofJapan raised its overnight call rate by 25 basis points to 0.5% in February, bringing it to itshighest level in a decade. This was the second interest rate hike after the July 2006 hike of25 basis points from zero to 0.25%. The bank cited the accelerating rate of growth in theeconomy as the main reason for the monetary tightening, a view which differed from that ofthe Japanese government mainly concerned about avoiding to stifle the nascent recovery.
Euro-zone data point to another year of solid growth, with continued expansion inmanufacturing, sustained activity in the services sector and improving labour markets.However, growth will be hampered this year by the slowdown in the global economy, thestrong euro, higher interest rates and the mildly restrictive fiscal policies. The composite PMIindex moved up slightly in February, while unemployment in January fell to 7.4%, the lowestlevel since 1999. Among member states, unemployment ranged between 3.6% in theNetherlands and 8.6% in Spain. Germany had an unemployment rate of 7.7% in January.Confidence remained high as shown by the European Commission’s latest sentiment index forthe Euro-zone which rebounded to 109.7 in February, after having retreated to 109.2 inJanuary, from the six-year high of 110.0 reached in October of last year. This was primarilydue to a rise in consumer confidence to its highest level since mid-2001, buoyed by betteremployment prospects and boding well for consumer spending. Business sentiment has alsoremained high in both the industrial and services sectors. There is however, a fall in the retailsector sentiment from last October's peak which may have been influenced by the GermanVAT rise. Seasonally adjusted retail sales themselves were weaker than expected in January,falling by 1% m-o-m, driven by a fall in Germany.
Annual money supply growth in January at 9.8% was near 17-year highs. However, the150 basis point increase in interest rates since December 2005 has helped to dampenhousehold borrowing. The annual growth rate of loans to households slowed to 7.9% inJanuary, from 8.2% in December 2006 and 9.1% in September. The ECB has been concernedthat strong mortgage lending would fuel a property price bubble. Consumer price inflation inJanuary remained below the European Central Bank’s target of 2%, declining to 1.8%.However, the ECB, as expected, resorted to another interest rate hike on March 8, lifting therefinancing rate by 25 basis points to 3.75% with further moves expected this year, since theECB sees the present rate as being still on the accommodative side. The ECB also has raisedits GDP forecast to 2.5% this year and it expects inflation to be around 1.8%. The Euro-zone trade surplus narrowed to 3.3 billion euro in December from 8.7 billion euro in November.The region achieved a small seasonally adjusted current account in the last four months of2006, helped by the fall in oil prices in the last quarter of the year which contributed to reducethe value of imports. Exports continued to perform well throughout 2006, despite the highercurrency, rising by 2.0% m-o-m and 14.9% y-o-y in December.
Former Soviet Union
In Russia inflation was 1.1 % in February which is down by 0.06 % compared to the last year.The progress relative to the 2006 period was due to the increase in food prices. RosStatreported that Russia exported 248.4 million metric tones of crude oil in 2006, down 2.0%from the figure for 2005 pointing to a rise in domestic consumption. Exports of crude oil inDecember 2006 amounted to 20.9 million tonnes, down 9.8% (y/y). The Russian Ministry ofEconomic Development and Trade is now projecting full-year growth at 6.05 % in 2007. Ourforecast for Russian GDP in 2007 is at 6.0%.
Despite increasing prices on natural gas, relatively high inflation and a current account deficit,Ukraine demonstrated “decent” economic growth in 2006. Ukrainian GDP growth reboundedto 7.0% in 2006, according to preliminary official estimates. Ukraine’s GDP is largely fueledby its vast export-oriented steel industry and mounting domestic consumption. Increasingprices on fuel imports, including natural gas and oil from Russia, have forced industry to cutdown on wasteful consumption and improve energy efficiency. The economic growth in 2007is forecast to moderate due to the less favorable global metals environment that was the maineconomic stimuli last year.
Recent data shows that Romania’s economy rebounded from a disappointing 4.4% in 2005 toreach 7.7% in 2006. The rising domestic demand was the main driver behind acceleration ingrowth. The decline in the agriculture sector in 2005 caused by severe flooding rebounded in2006. Net imports remained a drag on growth as imports expanded by 23% while exportsgrew by 10.6%.
The Chinese government expects GDP to rise about 8% in 2007, with the projection deliberatelypitched at a low level to signal the government’s intention to seek quality growth, as it focuseson making the structure of the economy more sound. In 2006, GDP grew at 10.7%, much higherthan the government’s target of around 8%, raising questions about the federal government’sability to control growth. Even with tighter measures to control capital flows, the governmenthas struggled to rein in excessive lending and investment in many regions that have longoperated independently. Our forecast for China’s growth is 9.4% in 2007.
On Tuesday 27 February, the Shanghai stock market plunged almost 9%. To many investorsthe sell-off was just the latest indication that share prices in the Chinese exchange have beendefying reality as China’s stock market system is still relatively immature. It seems that thefall was triggered by rumors that the Chinese government would impose a tax on share profitsto avoid a bubble – a move later denied by the government. Other worries added to the tensionin stock market worldwide after Alan Greenspan’s pessimistic view about the US economythis year. While stock market movements are not usually considered as a sign of the macroeconomic performance, it should be highlighted that in China the link between the stockmarket and the economy is even weaker than other similar markets. It serves largely to raisefunds for state companies, rather than the vibrant private sector. In moves to further stabilizethe market, the government will likely focus on tightening controls of illegal activity.
China’s trade surplus surged to its second-highest level on record in February 2007,foreshadowing further international tensions over China's exchange-rate system, With this inmind, Chinese officials have said that policies to reduce their nation’s trade surplus need time toshow results. The Chinese government announced that one of its priorities this year is to cut thetrade surplus to head off rising trade tensions with major trading partners such as the US and EU.The government would tackle this problem by boosting domestic consumption and increasingimports while encouraging more growth in the services sector.
In India, industrial output growth sustained momentum in January, as shown by official data.Total output rose by 10.9% y-o-y, which despite being slower than the revised 12.5% annualgain recorded in December, still exceeded expectations. Sustained output growth continues totest capacity limits and increase inflationary pressures. In the year through 24 February, thewholesale price index rose by 6.10%, close to the previous week’s gain of 6.05%. Thegovernment has cut administered fuel prices in an attempt to ease inflation.
OPEC Member Countries
The oil sector has played the leading role in the recovery of the Angolan economy. Thecountry grew by 11.2% in 2002, 20.6% in 2004 and 17.6% in 2006. Growth this year isforecast at 13.3%. However, Angola’s economic growth, though determined by double digitgrowth in the oil sector, has also trickled down into the non-oil sector. After the oil and gassector, which accounts for roughly half of Angola’s GDP, the biggest contributions to GDPcome from wholesale and retail trade, agriculture, forestry, and fisheries.
Inflation in Algeria rose by 1.8% y-o-y in January, down from 4.4% a month earlier accordingto the latest data released by Algeria’s National Statistics Office. The monthly decrease in CPIwas due to a 1.3% decrease in the cost of food from the previous month. Moderate inflation isforecasted this year despite increases in wages and expansionary fiscal policies suggesting atimely response from domestic supply.
Oil prices, the US dollar and inflation
The dollar lost some ground versus the euro and Swiss franc and fell marginally also againstthe yen in February, rising slightly against the pound sterling. The US currency fell by 0.58%versus the euro, 0.11% against the yen, and by 0.24% against the Swiss Franc. It rose by0.12% against the pound.
The euro’s strength versus the dollar was a reflection of the mounting evidence of improvedeconomic conditions in the Euro-zone and in anticipation of the rise in euro-zone interestrates in March. The fall of the yen was arrested in February and it hovered around 120 yen/$.The small interest rate hike by the Bank of Japan on February 21st did little to lift the currencybut it raised some fear that the carry trade may be unwinding.
In February, the OPEC Reference Basket rose by 7.33% to $54.45/b from $50.73/b inJanuary. In real terms (base July 1990=100), after accounting for inflation and currencyfluctuations, the Basket price rose by $2.4/b or 7.0% to $36.76/b from $34.35/b.