United States of America
While the performance of the US economy was stronger than expected in the second quarter, gathering financial clouds, rising unemployment and falling retail sales indicate the economy is on course for a slowdown in the second half of the year.
The financial risks to growth appear to be on the rise as the credit crisis deepens. The US Administration took control of the two mortgage giants Fannie Mae and Freddie Mac to avert the potential systemic risk their downfall would have posed. The companies together own or guarantee about $5 trillion in home loans, around half the country’s total and have so far incurred losses exceeding $14 billion, with more expected down the line. Both companies were placed into a government conservatorship under the Federal Housing Finance Agency, until solutions can be reached as to their future structure and role. Markets regained some calm after the takeover but were again strongly shaken after attempts to sell Lehhman Brothers, the fourth largest US investment bank, failed and it consequently filed for Chapter 11 bankruptcy on 15 September, with possibly serious consequences for the US financial sector and beyond. Soon afterwards, the Bank of Amercia announced it had reached an agreement to acquire Merrill Lynch. The landscape of US investment banks has in the course of just a few months radically changed. Equity markets have registered steep falls and the dollar shed some of its recent gains. The Fed responded by increasing banks’ access to funding and widening the range of securities it accepts as collateral and the pressure is on to reduce interest rates further.
The US economy recorded a 3.3% annualised rate of growth in the second quarter, higher than the initially estimated 1.9%, primarily due to upward revisions in exports and private inventory investments and a downward revision in imports. Net exports are now estimated to have contributed 3.1 percentage points to growth compared to 0.77 pp in 1Q08, while the private residential investment deducted 0.62 pp to growth compared to 1.12 pp in the previous three months. Private consumption expenditure, boosted by the tax rebates, added an upwardly revised 1.24 pp to growth compared to 0.61 pp in Q108.
However, retail sales dropped in August by 0.3% following a 0.5% drop in July, confirming the view that the temporary stimulative effects of the tax rebates have faded. Excluding automobiles, purchases were down 0.7%, the largest drop this year. Increased incentives provided by car manufacturers in August to encourage demand were successful in raising sales of cars and parts by 1.9%, representing the first gain since January 2008.
In its regional economic survey of the 12 Fed districts, the so-called “Beige Book”, the Fed reported that business and consumer spending across most of the U.S. were slow in August, while inflationary pressures were on the rise due to higher commodity costs. It was also reported that the general weakening of hiring was keeping a lid on wage increases. Meanwhile, August payrolls fell a higher-than-expected 84,000 and revisions piled 58,000 to job losses for June and July. The rate of unemployment in August climbed to 6.1%, a five-year high, from 5.7% in July. The steep increase in the jobless rate is due not only to a fall in employment of around 0.5 million jobs but more significantly to an increase in the size of the labour force of around 1.5 million. It is expected that the rate of unemployment will rise further in the coming months acting as a dampening factor on consumer spending.
Separately, the Institute for Supply Management's index of non- manufacturing businesses, which represents almost 90% of economic activity, increased to 50.6 from 49.5 in July. However, the index for manufacturing fell in August for the first time in three months to 49.9 from 50 in July, as companies slowed production and cut payrolls in the face of weakening consumer spending. Both surveys indicate a stagnating economy.
On the housing front, negative news dominated. Foreclosures accelerated in the second quarter to 2.75% from 2.47% in 1Q08. The mortgage delinquency rate of 6.41% was the highest since records began to be collected in 1979 by the Mortgage Bankers Association. Moreover, pending home sales, considered a leading indicator since it tracks contract signings, which are usually one to two months ahead of closings, fell 3.2% in July after rising 5.8% in June, as reported by the National Association of Realtors.
However, on the positive side, one notes that factory orders climbed a higher-than-expected 1.3% in July following a 2.1% increase in June, a sign that exports were still supporting the economy at the start of the third quarter. However, the stimulus from trade, which was the biggest in 28 years in the 2Q08, may wane as Europe's and Japan's economies decelerate and the dollar appreciation. In fact, the trade balance deteriorated markedly in July.
The US economy is estimated to expand at 1.8% rate this year, up 0.2 pp from last month and forecast to achieve 1.4% growth next year, up 0.1 pp.
Japan's economy contracted at a downwardly revised annualised rate of 3% during the second quarter of 2008 from an initial estimate of 2.4%, the steepest drop since 2001, on lower estimates for capital spending. Net exports, the main engine of growth in the past few years subtracted from growth in the second quarter for the first time in three years. Recent data into the third quarter also point to a stagnating economy raising the possibility of a technical recession. However, a recession, should it materialise is expected to be shallow and only of short duration. Japanese companies have shed excess capacity and debt in recent years and the recent decline in oil prices is seen to benefit Japan more than other economies. Japan has the added advantage of having been little affected by the credit crisis that has impacted the US and Europe. However, Japanese equity markets are also being impacted by the recent financial turmoil in the US and the yen has gained versus the dollar on further unwinding of carry trades.
Capital spending fell by 0.5% in 2Q08 from the preliminary estimate of 0.2% while consumer spending also dropped at the same rate, as salaries and wages failed to keep up with inflation. Further in July, real employee compensation decreased by 0.4% as the core consumer price index, excluding fresh food, rose to 2.4% from year ago, exceeding the two percent mark for the first time in a decade on higher food and energy prices. Japanese household spending continued to fall in July by 0.5% to an average 298,366 yen ($2,724.80) from a year earlier, the fifth straight month of decline. Meanwhile, machinery orders, a forward indicator of capital spending, dropped for the second month in July by 3.9% m-o-m after sliding 2.6% in June, in expectation of slowing global demand. The Economy Watchers index, a survey of service providers that deal with consumers, dropped to 28.3, the lowest since October 2001, from 29.3 in July.
The unemployment rate improved slightly in July to 4.0% from 4.1% in June, a two-year high, as a result of more jobs created in services sectors. However, job openings reached three-year lows, and the ratio of job openings to job seekers dropped to 0.89 in July, the lowest ratio since October 2004, and down from 0.91 in June, mainly due to fewer job offers in the construction, transportation and manufacturing sectors. The ratio had been below 1.0 since November 2007.
In response to higher prices and falling real income and profits, the Japanese government has announced a stimulus package. Although is overall value of the announced package is large, it includes only around ¥1.8 trillion ($17 bn) in additional government spending (0.3% of GDP), which is relatively modest compared to the US package of around 1% of GDP, and its macroeconomic effects are expected to be modest. The government also announced a one-off fixed-amount income tax cut within the fiscal year (ending 31 March, 2009). Details are still to be worked out and some delay is expected due to the government reshuffle. A large part of the spending is not likely to arrive until next year.
Overall, the Japanese economy is expected to grow at 0.8% this year -down 0.2 pp from last month, and by 1.0% in 2009, a downward revision of 0.1 pp.
In the euro-zone economies further signs of a widespread slowdown in the first two months of the third quarter imply that the region may be on the brink of a technical recession after the annualised drop of 0.8% in GDP in the second quarter. Retail sales across the region fell in July and manufacturing and service industries contracted for a third month in August. In Germany, the largest economy in the Euro-zone, manufacturing orders fell for the eighth straight month in July. The European Commission now forecasts that Germany and Spain as well as the UK could slip into recession. Euro-zone financial markets have also been shaken by the turmoil in the US and equity markets have registered strong falls. The European Central Bank (ECB) announced measures to provide additional liquidity to the financial sector.
Despite the slowing economy, the ECB kept its key interest rate unchanged at 4.25%, a seven year high, in an attempt to keep faster inflation from fueling wage increases, as well as announcing a tightening of the rules for lending to banks, thus raising the cost of borrowing. Inflation dropped to 3.8% in August from 4% in July but the ECB is afraid of second-round effects as inflation expectations are moving up. This can be seen from the wage negotiations in some Euro-zone countries such as Ireland and Germany. In the latter, IG Metall, the largest trade union in Germany representing 3.5 million members is seeking a 7-8% wage increase.
The purchasing managers' index (PMI), a key leading indicator of economic activity, remained below the 50 threshold level in August. Manufacturing activity contracted for the third straight month, recording a level of 47.6, slightly up from 47.4 in July, as reported by the research group Markit Economics. German firms reported shrinking output for the first time in three years.
Similarly, the region’s services purchasing managers index rose slightly to 48.5 in August, from July's five-year low of 48.3 but remained below the 50 threshold level. Germany's PMI services figure was revised up to 51.4, but was clearly lower than July's 53.1 level.
Moreover, Euro-zone industrial production fell a higher than expected 0.3% in July, the third consecutive drop. From a year earlier, euro-area output fell 1.7% after declining 0.8% in June. Production in Germany fell 1.8% from the previous month, while French output rose 1.2% after declining in the previous two months. Italian production slipped 1.1 %.
Data from the European Union Statistical Office showed that payrolls also grew at the slowest pace of 0.2% in almost two years during the second quarter compared to 0.3% in 1Q08. Annual growth in payrolls slowed to 1.2% from 1.6% in the previous quarter. The statistics office estimates that the total number of people employed in the Euro-zone was 146 million in the second quarter.
Euro-zone growth has been revised down 0.1 pp this year and next from last month’s forecast. The region is expected to grow 1.3% this year moderating to 1.0% in 2009.
Former Soviet Union
Russia’s GDP grew by 8% y-o-y in the first half of 2008 according to the Russian Federal Statistics Service (Rosstat). The country’s GDP was up 7.5% in the second quarter of 2008, slower than the 8.1% expansion recorded a year ago. In the second quarter, fishing, trade, transport and communications, and construction posted high growth, while mineral exploration fell into decline. Inflation, on the other hand, continues to remain high. Producer price inflation ran at 33.7% in July, while consumer prices rose 0.4% m-o-m in August. The government predicts that Russia’s GDP could grow 7.6-7.8% for the whole of 2008, lower than the 8.1% recorded last year. Russia’s stock market has tumbled almost 50% since May and foreign investors have pulled out billions of dollars responding to the geopolitical tensions and the mortgage crisis in the US and Europe. As foreign capital investment is expected to fall by 45% this year to around $45 bn, the government might use its $32 bn national wealth fund to prop up the country's financial markets.
Kazakhstan sees the economy growing at 5-7% annually in the next three years and inflation easing, according to a draft three-year budget report. Central Asia’s largest economy has suffered from the global liquidity squeeze coupled with runaway inflation. The government sees gross domestic product (GDP) growth slowing down to 5.3% this year from 8.7% last year.
Industrial output in China rose 12.8% in August from a year earlier, according to the National Statistics Bureau (NSB), after gaining 14.7% in July. The slowing trend of industrial production growth in China has increased the possibility that the government will have to stimulate the economy. Weaker export demand and factory shutdowns for the Olympics — before the Olympics, China’s government had restricted industrial production and construction in Beijing and surrounding provinces to reduce air pollution — lie behind this slowest growth pace in six years. China's export growth slowed in August to 21.1% compared to July’s growth of 26.9% from a year earlier. Concern about growth and moderating inflation will encourage the Chinese authorities to cut bank’s reserve requirements and slow the pace of the yuan appreciation. China’s government has already loosened loan quotas — restrictions on how much banks can lend — and raised export-tax rebates for garments and textiles. Infrastructure spending is a possible tool for stimulating economic growth.
Despite the sharp fall in inflation last month, retail sales have strongly grown by 23.2% in the year to August according to the National Bureau of Statistics (NBS), just off July’s record pace of 23.3%. Rising incomes, supported by urbanisation, are fuelling consumption. Incomes in the urban areas rose by 14.4% in the first half of 2008 from a year earlier, or 6.3% in real terms; rural cash incomes jumped 19.8%, or 10.3% in real terms.
The consumer price index dropped to 4.9% y-o-y in August, the fourth consecutive month of slowing inflation according to NBS, which is far below February’s near 12-year high of 8.7%. Food prices, the main driver of inflation since last year, were up 10.3% in August from a year earlier. In July, food inflation had been 14.4%. This could be a reflection of better food supply together with slowing growth of consumption. The evidence for the latter includes the sluggish car sales, falling revenues at major electronic retailers and weakening enthusiasm for buying homes.
India's economic growth slowed to its lowest rate in three years in the second quarter of 2008 as rising inflation and higher interest rates crimped domestic consumption and investment. India's GDP grew 7.9% in the fiscal first quarter, slowing from an 8.8% expansion in the preceding quarter and 9.2% growth in the same quarter last year. In contrast, India’s annual industrial output rose more than expected in July, driven by capital goods production, signaling continuing investment in manufacturing and underlying economic strength in the face of higher interest rates.
OPEC Member Countries
Inflation in Saudi Arabia will grow at a slower pace in the third quarter, reflecting a jump in prices during the same period last year and government food subsidies. Qatar’s economy rose by around 15% in the first quarter of this year extending its rapid growth trend, according to the Qatari Planning Council, the country's official statistics agency. The report attributed the surge to higher oil prices and a rapid growth in the country's liquefied natural gas exports, which have allowed Qatar to amass huge wealth and record the highest growth rates in the region over the past few years.
Oil prices, the US dollar and inflation
The US dollar moved up strongly in August against the major currencies in the modified Geneva I + US dollar basket. The dollar rose 5.1% versus the euro, and gained 2.3% against the yen, 5.3% versus the pound sterling, and 5.7% against the Swiss franc. Vis-à-vis the modified Geneva I + US dollar basket, the dollar posted a gain of over 3.2%. The US currency averaged $1.4969/€ in August from $1.5769/ in July.
The US currency’s strong recovery, which took off in mid-July, gained momentum in August and continued into September. By September 11, the dollar had risen to a one-year high versus the euro of $1.3934 or 13% over the course of eight weeks. The reversal of trend for the dollar seen to reflect evidence of a sharp slowdown in economic activity in the euro-zone and Japan as well as the general deceleration of growth in the rest of the world. However, the dollar has lost some ground in the last few days reflecting the recent financial turbulence in the US.
In August, the OPEC Reference Basket dropped by $18.8/b or 14.3% to $112.41 from $131.22/b in July. In real terms (base June 2001=100), after accounting for inflation and currency fluctuations, the Basket price fell $9.45/b or 12.0% to $69.28/b from $78.73/b. The dollar appreciated by more than 3.2%, as measured against the import-weighted modified Geneva I+US dollar basket, while inflation eroded the value of the barrel by over 0.5%.