The Global Economy No. 5 - August 7, 2012


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The Global Economy No. 5 - August 7, 2012: The global economy is living dangerously

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The Global Economy No. 5 - August 7, 2012

  1. 1. The Global EconomyMonthly letter from Swedbank’s Economic Research Departmentby Cecilia Hermansson No. 5 • 7 August 2012 The global economy is living dangerously During the second quarter the global economy slowed. Confidence variables and leading indicators suggest that the third quarter will also be weak. There aren’t any economic policies that can reverse this trend, since monetary policy isnt having an effect and there is little support for expansive, debt-financed fiscal policy, despite that lending costs in several countries are low. The problem is that politicians aren’t addressing medium-term challenges (US, Japan) or lack the courage to stimulate their economies short-term before tightening their belts in the longer term (UK, Germany). The fragmentation of Euro area financial markets has worsened and this is worrying. The ECB wants to link purchases of government bonds to support within the EFSF/ESM funds and is shifting more toward quantitative easing. It’s only reasonable that responsibility is placed on politicians, but it will take time for Spain and Italy to apply for support, which is risky and could mean continued high financing costs. While the decline in two-year bond yields from these countries provides a glimmer of hope, there is a risk that it will be short-lived and will lead to increased risk-taking in their financing by way of shorter maturities. Emerging countries account for nearly 80% of global growth. Much of the responsibility for avoiding a global recession rests with them, and considering that their potential growth is likely to shrink as investors’ risk aversion rises, there will be an increased need for structural reforms in these countries as well.Slowdown under way Chinese data showed that annual GDP growth fell from 8.1% in the first quarter to 7.6% in the secondEconomic data released this spring and summer by quarter. This is the weakest rate in three years. Ifthe US, Asia and Europe have been mixed with a quarterly statistics are to be believed, growthbias on the downside. GDP numbers for the second improved from 1.6% to 1.8% in seasonally adjustedquarter have not been finalised, but most of the terms. One way or another, there is little doubt thatcountries that have published their data reported China is in a period of weak development. Industrialshrinking economic activity or slower growth. All and electricity production as well as housing areindications are that the third quarter will do little to signalling a slowdown. Credit growth is rising again,change market sentiment. which is natural considering that monetaryStudying the Purchasing Managers Index (PMI) for conditions have eased. Lending won’t have theindustry provides an indication of where we are same impact on growth as it did in 2008-2009,headed. A reading of below 50 signals a slowdown. however, since the housing market is now riskierThe situation is most acute in the euro area, where and politicians and companies are both being morethe index fell to 44 in July, with the UK in the same cautious about taking on substantial debt.territory at 45.4. At the same time the US crept GDP growth (Q/Q) in the US slid from 1% in the lastbelow 50 for the second consecutive month. quarter of 2011 and 0.5% in the first quarter thisAlthough China’s purchasing managers still expect year to 0.4% in the second quarter. Weak incomea decline, its index rose to 49.3 from 48.2. growth and low consumer confidence have curtailed household spending, and retail sales have gradually Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46-8-5859 7740 E-mail: Internet: Responsible publisher: Cecilia Hermansson, +46-8- 5859 7720, Magnus Alvesson, +46-8-5859 3341, Jörgen Kennemar, +46-8-5859 7730, ISSN 1103-4897
  2. 2. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 5 • 7 August 2012fallen. Uncertainty about the government’s budget GDP fell by 0.3% in the last quarter of 2011 and thewill increasingly impact growth prospects, with GDP first quarter this year. The decline was expectedpotentially taking a big hit early next year if a considering that unemployment has reached 24.6%political resolution isn’t found to the impending and concerns have grown whether the country will“fiscal cliff”, although the willingness of households be able to finance its budget without help. Afterto spend and businesses to invest and hire is receiving €100 billion to shore up its banks, theprobably already being affected this year. focus has shifted to Spain’s regions’ reluctance towards meeting demands to reduce deficits. SpainPurchasing Managers Index (PMI) for various won’t be able to handle 10-year bond yields nearcountries/regions and globally 7% in the long term. Two-year bond yields fell to 65 slightly over 4%, however, after the ECB’s press 60 conference last week (see next section). 55 The image of a euro area in crisis has been reinforced by what appears to be slowing economic 50 activity in Germany. Its PMI has fallen to 43 at the same time that the IFO barometer has turned lower 45 US and the EU Commission’s confidence survey 40 UK Japan indicated weakness among households and Euro area China businesses. Second-quarter growth appears to fall 35 India within a range with both negative and positive Global growth (-0.1–0.2%) with great uncertainty. 30 25 Future confidence among industrial companies (40%), 07 08 09 10 11 12 service companies (30%), the construction sector (5%), retailers (5%) and households (20%), according to the EU Commission – 100 represents a long-term average Source: Reuters EcoWin 120After a spring with weak job numbers in the US, theJuly results were a positive surprise with a total of 115163 000 new jobs created, including 172 000 in the 110private sector at the same time that the public 105sector lost 9 000. In spite of this, unemployment 100inched up from 8.2% to 8.3%. One reason may bethat different surveys that serve as a basis for the 95 Indextwo types of data. A larger labour supply also 90 Germanycaused unemployment to rise. The current US 85 Euro areagrowth rate is enough to stabilise unemployment, Spain 80 Greecebut not to significantly reduce it, which is a major 75problem for the administration leading up to thepresidential election in November. 70 65A positive factor are the green shoots in the 05 06 07 08 09 10 11 12housing market, where housing starts are rising Source: Reuters EcoWinfrom a low level, sales of existing homes haveincreased in the last year and housing prices have Outside the euro area the UK continued to struggle.shown slight gains since the beginning of 2012. GDP shrunk for the third consecutive quarter, not toThere are still many available homes on the market mention at an accelerating rate, from 0.4% andand foreclosures are affecting prices, but the 0.3% in the two previous quarters to 0.7% in themarket appears to have bottomed out. This doesn’t second quarter. Blame has been placed on themean, however, that prices will rise quickly. The weather and the Queens Diamond Jubilee, ahousing market won’t be able to provide enough national holiday, but the fact remains that the UK isgrowth when fiscal and euro area developments are in recession. The Olympics probably wont haveholding back economic activity. much of an effect, since the country at the same time lost its ordinary tourists.In Europe, preliminary GDP numbers will bepublished on August 14, with a second, more Criticism against the government has grown, sincereliable estimate due on September 6. Spain noted the budget consolidation is constraining domestica 0.4% quarterly decline in the second quarter after demand. At the same time the UK is being hurt by 2 (4)
  3. 3. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 5 • 7 August 2012slower demand from the euro area. The The problem is that looser monetary policy wont dogovernment will have to ease up on austerity if the much to alleviate the euro zone’s growing realrecession worsens, but at the same time would lose economic and financial burden as well as theface. It can still be claimed that the labour market is worrying fragmentation of financial markets. Itperforming more positively than growth data makes sense to further cut interest rates, but thesuggest. In the last two years employment has risen focus is and should be on more unconventionalby 420 000, with the private sector adding 845 000 tools to address the crisis. For Spain and Italy,jobs and the public sector cutting 425 000. This also these tools are crucial to break the vicious cycle ofmeans that productivity has declined. weak confidence towards these countries, the euro zone’s institutional framework, the euro’s survival;Economic policy won’t turn things around. Spain and the steadily rising bond yields.and especially the UK could take a slower approachto their budget consolidation given the political Spain’s government bond yields (2- and 10-year)support for doing so. In the UK, it’s up to the 8government, while in Spains case the euro areaalso has a say. Lending costs in the UK are very 7low, and if medium-term policy is correctlycommunicated it could maintain the confidence of 6the financial market even if the pace ofconsolidation slows. The ECB could further cut its Percentbenchmark rate and develop quantitative easing. 5The UK, US and Japan are likely to expandmonetary stimulus programmes by buying 4government bonds or other assets in the second-hand market. The effects on growth won’t be great, 3however, even if it makes stock traders and others 2 yr government bondin the financial market happy – temporarily. 10 yr government bond 2 jan mar maj jul sep nov jan mar maj julECB ties bond-buying to ESM – is that 11 12 Source: Reuters EcoWinenough?The recession is worsening in the euro area and From at least one perspective ECB President Mariounemployment continues to rise in several Draghi’s latest speech seems to have made acountries. In July unemployment stabilised at difference: two-year bond yields have turned lower11.2%, but is likely to continue to trend higher. At (see diagram above). This is because the ECB hasthe same time inflation is slowing. In July it was announced it will buy bonds with shorter maturitiesdown to 2.4%, from just over 3% at the end of last from countries that have applied to the EFSF/ESMyear. The ECB expects inflation to fall below 2% programme and had the terms for such supportnext year, with the possibility that the repo rate approved.could be further cut from its current level of 0.75%. The benefit is that the process is being tightened upUnemployment (%) and that politicians will have to take responsibility 25,0 for implementing reforms and budget consolidation Germany within the framework of EFSF/ESM. Another 22,5 Euro area Spain advantage is that EFSF/ESM will receive expanded France 20,0 Greece financing and that the programme could turn to Ireland Italy quantitative easing if the purchases in the second- 17,5 Portugal hand market aren’t sterilised. The disadvantage is 15,0 that it takes time to launch such a programme and itPercent could be stigmatising to seek support. Spain hasnt 12,5 ruled out asking for help, but first wants to know 10,0 what the ECB’s programme will look like in practice. It isn’t likely to ask for support until October at the 7,5 earliest, and Italy will only do so after Spain does. 5,0 Until then interest rates could rise again, even for two-year bonds. The ECB’s role as a “lender of last 2,5 07 08 09 10 11 12 resort” is contingent on the political process, which Source: Reuters EcoWin leaves little room for short-term action. Focusing on 3 (4)
  4. 4. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 5 • 7 August 2012short-term maturities also poses a risk, since the It doesnt make much sense really to lump allloans often have to be rolled over. The question of emerging countries together given the differentseniority – whether or not the ECB takes conditions they face. Several Latin Americanprecedence over private creditors in the event of a countries have little savings and weak productivitydebt reconstruction – will also be taken up by the growth, while China has exceedingly high savingsworking groups now drafting the plan. and is maintaining good productivity growth. In Chinas case capacity has been expanded quickly,The ECB could complement the bond-buying which could lead to overcapacity if demand from theprogramme now being drafted with new fixed-rate West shrinks even more. India and Brazil areloans at low interest rates (LTRO), amended rules dealing with capacity shortages after several yearson collateral, negative interest rates on deposits of insufficient investment, which means that ratewith the ECB, etc. It isn’t likely, however, that Spain cuts could be one (perhaps risky) way to stimulateand Italy will be helped much. They may need the growth, since potential growth may have fallen,“bazooka” Draghi talked about, but which doesnt which could quickly lead to overheating.yet exist. The ESM hasn’t been approved by theGerman constitutional court and a decision isn’t Although conditions differ, there is reason to askexpected until September 12, which will include its whether potential growth for this group of countriesopinion whether the ESM should receive a banking will change if the West undergoes an acid test andlicense that expands its lending capability. faces major challenges for years to come.Germanys view on the way ECB prefer goingforward is still unclear. The government seem to One possible change for emerging countries is ifendorse it, while Bundesbank is hesitating. investors’ risk appetite weakens and capital inflows shrink. They could in fact change direction, whichIf the ESM can be expanded through either bigger would impact investment and productivity growth –bond purchases by the ECB in the second-hand and in doing so potential growth. Those emergingmarket and/or with a banking license, it would be a countries that are dependent on commodity exportsstep toward making the ECB a lender of last resort, also face challenges now that prices have fallen.but only for countries that have received approval On the other hand, those that are dependent onbecause they are implementing reforms. This is commodity imports and to date have subsidisedonly reasonable, but the problem is that it could be energy consumption, which has a major negativean awfully slow political process and the self- impact on their budgets, will benefit.fulfilling rise in yields that we have already seen inthe bond market could continue, not only The US, Japan and Europe will have to implementthreatening the stability of Spain and Italy but also a number of structural reforms to meet theof Europe as a whole and the global economy. challenges in the years ahead. The same applies to emerging countries, even if they dont have a “knifeEmerging countries – is potential growth at their throats”. Their own imbalances will come tolower now? the surface when trade and capital inflows (and growth) no longer come automatically. For countriesNearly 80% of growth in the global economy is that are “sitting on their hands”, potential growth isbeing generated by emerging countries. This figure likely to decline in the years ahead, if it hasntwill only gradually shrink to 70% in the years ahead, already.which makes the West highly dependent on thecontinued development of emerging economies. Cecilia HermanssonSwedbankEconomic Research Department Swedbank’s monthly The Global Economy newsletter is published as a service to our customers. We believe that we have used reliable sources and methods in the preparationSE-105 34 Stockholm, Sweden of the analyses reported in this publication. However, we cannot guarantee the accuracy orPhone +46-8-5859 7740 completeness of the report and cannot be held responsible for any error or omission in underlying material or its use. Readers are encouraged to base any (investment) on other material as well. Neither Swedbank nor its employees may be held responsible forLegally responsible publisher losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’sCecilia Hermansson, +46-88-5859 7720. monthly The Global Economy newsletter.Magnus Alvesson, +46-8-5859 3341Jörgen Kennemar, +46-8-5859 7730 4 (4)