United States of America
Economic indicators point to a slowdown in the pace of economic activity in the first quarter of 2007 reflecting the ongoing contraction in the housing sector and continued weakness in the manufacturing sector. However, the data is mixed and not all gloomy. Continued health in the labour markets is serving to allay fears of a strong slowdown. The hiring spurt was seen as evidence that the troubles in housing, including weakness in sub-prime mortgage lending, were not spreading to the rest of the economy. Despite a two-week rise in the initial claims for unemployment benefits, the labour market situation remains sound. The economy is reported to have created 180,000 new jobs in March, partly compensating for the weather-related weak February employment figures. The unemployment rate fell to 4.4%, the lowest level since 2001, and 0.3% lower than a year ago, well below the 5% generally interpreted as the level of employment consistent with stable inflation.
The continued worry about inflation, evident from the deliberations of the Federal Reserve Board indicates that monetary loosening is not to be expected any time soon. The core personal consumption expenditure deflator, the preferred Fed measure for inflation, rose by 0.3% in February or 2.4% y-o-y, well above the Fed comfort zone of around 2%. The Fed opted to leave US interest rates unchanged in March at 5.25%. Fed statements continue to indicate more concern about inflation than growth although admittance of downside risks to growth is more evident. The Fed is also concerned about the pass-through of higher import prices into general inflation- imports accounting for around 17% of all goods and services purchased. Import prices rose by 1.7% in March following a revised 0.1% rise in February, led by the rise in petroleum prices. US producer prices also rose a higher-than-expected 1% in March following a 1.3% gain in February. Excluding food and fuels, producer prices were unchanged in March.
On the other hand, strong labour markets augur well for private consumption. Personal incomes have grown at a 6.6% annual rate in the six months to February 2007 and are expected to have risen further in March. Preliminary indicators also show that retail sales were growing at a healthy pace. US retailers reported stronger than expected sales in March assisted by the early Easter season and warm weather. However, it is expected that retail sale growth will soften in coming months. On the other hand, indicators for the developments in the ailing housing sector are mixed. While the sales of existing homes has risen in February by 3.9%m/m, and mortgage applications for home purchases have increased, new home sales, seen as the key indicator for home construction, weakened sharply in January and February. Moreover, weak house prices are not expected to improve in 2007. The National Association of Realtors expects a 0.7% decline inthe median price of existing homes sold in 2007, for the first time in nearly forty years.
Meanwhile, other reports show that economic growth has remained sluggish. Capital goodsorders, a forward indicator for business investment fell by 2.1% on the year in February following a 9% year-on-year rise in 2006. The overall ISM business survey index for manufacturing fell in March to 50.9 from a level of 52.3 in February. The components for both production and new orders registered a drop while the price component showed a rise. The growth in the services sector also slowed down as shown by the ISM services index, which fell to 52.4% from 54.3% in February, registering the lowest level since April 2003. While still above 50, the index indicates slow growth in the services sector, but no contraction. The index for services has remained above 50% for 48 months and has sustained growth and employment last year even as the manufacturing sector was flagging. In addition, the Commerce Department in a separate report said that factory orders rose by a lower than expected 1.0% in February. Overall, the present weakness in the economy is seen as a mid-term slowdown rather than the beginning of a recession. However, real GDP growth in the first quarter is expected to be modest but is expected to pick up later in the year. For the whole year a 2.3% growth is forecast, 0.1percentage points lower than last month’s assessment.
The Japanese economy continues to exhibit signs of strength, following the stellar performance in the fourth quarter, when the annualized growth rate of growth reached 5.5%, the highest since Q4 2003. However, price data remains weak indicating that the Bank of Japan will be slow in raising interest rates again this year. The closely watched quarterly Tankan survey of business confidence in March was slightly weaker than the two previous reports, amid concerns about the global economic outlook, in particular the U.S economy, and especially among the big Japanese manufacturers, for which the US is a major export destination. However, the report indicated relatively bullish plans for capital spending in the coming months. Overall, the Tankan underlined that the corporate sector remains vigorous. However, generally, the earnings expectations are lower than for last year. Industrial production fell 0.2% in February from a month earlier, but is expected to rise in March and April. Output in the manufacturing sector, the main component of industrial production, is expected to rise by 1.5% in March and by 1.3% in April.
Japan's unemployment rate stayed at 4.0% in February, and overall household spending in February rose above expectations at a rate of 1.3% from a year earlier, following a rise of 0.6%in January. The increasing strength of consumer demand was demonstrated by the Economy Watchers index, which is a survey that measures the strength of domestic demand, which rose to 50.8 points from 49.2 a month earlier. For the first time since October, the index was above 50 which marks the threshold above which optimists outnumber pessimists.
The nationwide core consumer prices, excluding volatile fresh food, fell 0.1% in February from a year ago, the first drop in 10 months. The core CPI for the Tokyo area, which is announced a month before nationwide figures, also fell 0.1% in March. The Bank of Japan (BoJ) is of the opinion that prices are in a broad uptrend in the long run even though core CPI growth may turn negative in the near term due to falling crude oil prices. However, these figures add weight to the view that the present lack of inflation will slow down the pace of credit tightening. The BoJ, as expected kept interest rates unchanged at 0.5% during its latest policy board meeting on April 9-10 and further tightening is not expected before the third quarter at the earliest. Interestingly, Japan's producer-price inflation accelerated for the first time in six months in March as higher oil prices pushed up the cost of gasoline and chemical materials. The index of energy and raw materials prices climbed 2% from a year earlier after rising a revised 1.7% in February.
The external sector continued to contribute to growth with Japan's trade surplus unexpectedly rising in February by 7.7% from year earlier on continued firmness in export growth. Similarly, the current account surplus rose by 4.9% y-o-y to $20.3bn with strong increases in both exports and imports, the latter reflecting strengthening domestic demand. Overall, the Japanese economy is expected to achieve a growth rate of 2.0% this year from 2.2% last year, as higher domestic consumption y partly offsets the expected slower export growth.
It is expected that growth in the Euro-zone will continue to be above trend this year. There are still few signs of the expected slowing down following last year’s fastest pace of growth in six years. Growth in services, which account for the biggest part of the euro-area economy, held close to the fastest pace in six months. The employment situation continued to improve and consumer and business confidence rose to the highest level since 2001. Unemployment fell to 7.3% in February, the lowest rate since the introduction of the euro in 1999. The strong rise in employment bodes well for private consumption spending during 2007. However, Europe's manufacturing growth slowed in March after export demand cooled.
Inflation has remained below the European Central Bank’s (ECB) 2% ceiling for seven straight months and is forecast by the central bank to average 1.8% in 2007. Nevertheless, it is widely expected that the ECB will continue its monetary tightening cycle with a further rise in interest rate, usually signaled ahead of time, with the next rise expected around June. The ECB last raised interest rates by 25 basis points to 3.75% on March 8, but has left them unchanged in its meeting on April 12. The ECB believes current rates, which are still lower than the last peak of 4.75% reached in 2001, are accommodating to economic growth. While mortgage lending growth has decelerated, the ECB continues to worry about the strong growth in the money supply, seen as a gauge for future inflation. In February, the money supply growth accelerated at the strongest pace in 17 years.
In Germany, real manufacturing orders rose by 3.9% m/m in February on a seasonally adjusted basis, recovering from a temporary drop of 0.3% m/m in January. The fall was attributed to the dampening effect of the value-added tax. Moreover, the Ifo survey of 7000 businesses rebounded in March. German growth in 2007 has been revised up by 0.2 percentage points to 1.9%, following the 2.7% growth reached in 2006. For the entire Euro-zone, the forecast has also been revised slightly upwards by 0.1 percentage points to 2.3% for this year, slightly lower than the European Commission’s more optimistic 2.5% forecast.
Former Soviet Union
The Russian Economic Development and Trade Ministry raised its forecast for GDP growth in 2007 from 6.2% to 6.5%. Our forecast is slightly lower at 6.1%, 0.1% higher than last month, compared to 6.7% in 2006. The official revision followed the positive results of the first two months of 2007 and a review of the forecast for industrial production. Russian GDP and industrial production grew 8.4% and 8.6% respectively over January and February 2007 according to the Ministry. The forecast for industrial production in 2007 has also been raised to 5.2% from 4.3%. Inflation is expected to be 7.4 % in April. In the first two months of 2007, inflation decreased by 8.2% and 7.6% m-o-m respectively, compared with 10.7% and 11.2% in the same month a year ago. Inflation is projected to drop to 5.5% in three years. Energy export revenues went down in Russia as a result of the warm winter in Europe. Energy exports accounted for 69.2% of total export revenues in January 2007, down from 71.9%. Revenues from the oil and gas sectors are projected at 8.2% of GDP in 2007, but are expected to decrease in 2008, 2009 and 2010 to 7.1%, 6.0% and 5.3% of the GDP, respectively. Gross expenditures on fixed capital investment were 19.6% higher y-o-y in February 2007 and were up 21.2% in the first two months of 2007. Construction activity rose to 21.3% in February and was up 25.4% cumulatively in 2007.
Most economic indicators point to a strong start for 2007 across the developing countries with China and India leading the way. The slowdown in the US economy may have some effect on demand for Asian exports, but its overall impact on the region is likely to be relatively well contained.
In Asia, economies are performing robustly. The Chinese economy is forecast to have grown by 11% in the first quarter as predicted by the State Information Center. The report found that because consumption is increasing rapidly, GDP is expected to increase about 11 % in the first quarter. In February, the State Information Center estimated that the growth rate of GDP in the first quarter would be 10.2%. In continuation of its attempts to moderate growth this year, the People’s Bank of China (PBC) has taken two important measures. It raised interest rates and increased reserve requirements for banks. The PBC decided to raise the benchmark interest rate for the yuan lending and deposits for financial institutions, effective 18 March 2007. The benchmark rate for one-year deposit was raised by 0.27 percentage points from the current level of 2.52% to 2.79%. The one-year benchmark lending rate was raised by 0.27 percentage points from 6.12% to 6.39%. PBC has also increased the amount of funds it requires commercial banks to keep on deposit with the authorities for the sixth time in less than a year, the latest of a series of measures aimed at managing liquidity in the financial system.
Growth in India is intensifying as data show that industrial growth achieved 10.9% in January from a year earlier. In February, India’s industrial production growth probably accelerated again to 11.2% from a year earlier, vindicating the central bank’s unexpected interest rate increase a fortnight ago to dampen consumer demand and curb inflation. Additionally the Reserve Bank of India (RBI) raised the credit reserve ratio to 6% from 5.5% to withdraw liquidity from the banking system. Indian commercial banks are now rapidly increasing the lending rate in line with the RBI’s policy for fighting inflation after months of governmental pressure not to do so.
A similar growth momentum prevails in Latin America. Recent data revisions in Brazil showed that the economy is larger than previously estimated. The Brazilian Census Bureau (IBGE) adjusted its methodology for measuring GDP growth to better reflect activity in the informal sector and the growing importance of technology and financial services in the economy, among other factors. For 2005, the IBGE’s new methodology raised GDP to 2.9% from 2.3%. For 2004,the IBGE increased GDP growth to 5.7% from 4.9%. For 2003, the new figure was 1.1%, upfrom 0.5%, while for 2002 the new figure was 2.7%, up from 1.9%. Anticipated further easing of the monetary policy (14 successive interest rate reductions since September 2005) will encourage private consumption and accelerate fixed investment, making both components prime drivers for growth this year.
OPEC Member Countries
Preliminary figures from the Banco Central de Venezuela (BCV) indicate that real GDP rose by 10.3% in 2006. Growth in Venezuela has been very strong in the last three years, exceeding 10% in 2004 and 2006. The high investment is partly attributed to the governments’ heavy spending on infrastructure projects and large purchases of imported machinery and equipment by the private sector. The non-oil sector grew by 11.7% in the last two years while petroleum output declined by 1.9%. Inflation rose by 2% in January 2007, which brought the 12-month average rate to above 18%. The government intends to impose corrective measures to bring inflation down to the target of 10-12%. In Algeria, real GDP growth slowed in 2006 from 5.3% to 3.0% as a result of a small decline in hydrocarbons output. According to the government, the real growth in the non-hydrocarbon sectors reached 4.8% in 2006 reflecting the high level of public investment in housing and infrastructure.
Oil prices, the US dollar and inflation The dollar lost ground versus the euro, the yen and the Swiss franc while rising somewhat against the pound sterling in March. The US currency fell by 1.28% versus the euro, 2.63% against the yen, and by 1.85% against the Swiss Franc. It rose by 0.50% against the pound.
The euro’s strength versus the dollar, reaching levels not seen since January 2005, was a reflection of the narrowing interest rate differential between the dollar and the euro, and the continued worries concerning the US economy, in particular the gaping current account deficit. The dollar weakened even more against the yen. The Japanese currency’s strength was partly due to repatriation of funds ahead of the end of the Japanese fiscal year and the gradual unwinding of the yen “carry trade” as investors become more risk averse.
In March, the OPEC Reference Basket rose by 7.38% to $58.47/b from $54.45/b in February. In real terms (base July 1990=100), after accounting for inflation and currency fluctuations, the Basket price rose by $2.3/b or 6.3% to $39.09/b from $36.76/b.