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17 June 2013
Standard Life Investments’ Global Strategy team provide regular analysis of the key economic data that has been influencing financial markets.
Available on a weekly basis, the Macro Digest takes a detailed look at the global economic issues that have been impacting our investment strategy. The regional approach aims to provide an easy-to-navigate guide to the most recent developments in the global economy.
UK - Trend growth – for now
There may be scepticism about the soundness of the UK economic recovery but there is increasing realisation that it is likely to have strengthened in the second quarter of the year. So much so that 2013 GDP forecasts are already being raised. Unless this proves to be a false dawn, growth looks likely to be nearer 1.25% this year versus the recent consensus of just 0.7%.
Where is the new-found optimism? Although Q1 GDP growth was 0.3%, the economy ended the quarter on a significantly stronger footing. In other words, the level of GDP at the end of March was higher than the average for the quarter as a whole, meaning that even a flat economy in Q2 would result in a 0.6% jump in GDP. Any growth would obviously see a higher GDP figure.
For example, industrial production rose by just 0.1% in April but because of the favourable base effects it would register quarterly growth of 0.9% in Q2 even if it flatlined in May and June. Construction spending was over 1% higher in March than the Q1 average and recent figures suggest a continued improvement. Output is now down around 1% compared to a year ago, as against recent declines of over 7%. Of course, there could be a setback – but none of the anecdotal evidence suggests such a likelihood.
One of the sceptics is Paul Fisher of the Bank of England's monetary policy committee (MPC). He has warned that the UK's recovery 'trails that of the US and will require policy to be kept looser for longer'. Now Fisher has been an MPC dove, continuing to call for more QE, so his bias is plain. And it seems most likely that the UK economy will outperform the US in Q2 with growth at, or around, trend. However, unless forecasts for the year rise further, growth in the second half of the year will fall back below trend.
A key concern that tempers expectations of just how strongly the economy may grow is the continued squeeze on household spending power. Although CPI inflation fell back a little to 2.4% in April, average earnings growth is only running at 0.9% (excluding bonuses). That gap seems unlikely to close any time soon, with unemployment levels still around 2.5 million.
The rest of the labour market report was mixed. Employment rose another 24,000 in the three months to April but most of that - 21,000 - was due to gains in self employment. Full-time jobs were down 4,000 on the quarter but vacancies were up 3.9%, corroborating the stronger economy story. However, that may not necessarily result in healthy job gains. The problem, as has been the case in the US, is that employment intentions are not always met, due to skills mismatching.
A more active housing market is one of the factors driving the pick-up in both construction and the economy. The RICS survey findings for May reported an acceleration in both new buyer enquiries and new instructions to sell. The report attributes a large part of the improvement to the Funding for Lending Scheme, with average rates on a 2-year fixed, 75% loan-to-value mortgage down another 17 basis points (bps) in March, to a record 2.70% low.
House prices are now rising in over half of the main regions, compared to less than 20% in March, with positive expectations in nine of the 11 regions. This rise in prices may well lead to stronger household spending if it slows the pace of rebuilding equity in housing, which has been a drain on spending power since the crisis started.
US – A new lease of life
What with fiscal cliffs and sequesters, the US economy had been expected to slow significantly over the early months of this year. In the event, underlying GDP growth of around 2.0% has been maintained throughout. While the early June data releases had suggested quarterly annualised growth of just 1.2% in Q2, the May retail sales figure raised that expectation to 1.8%. That, of course, is just an estimate and subsequent data could change the figure. However, it does now seem unlikely that the worst fears about the impact of cliffs and sequesters will be realised.
May retail sales were up 0.6%, with core sales up 0.3%. The April number was revised up to a gain of 0.1% versus an original -0.2% estimate. Auto sales, in particular, were buoyant (up 1.8% in May) with total sales expected to reach 15 million this year, compared to 14.5 million in 2012. And a key development is that US brands have been gaining market share from Japanese and Korean producers – the US share is now 45.9%, up from 44.4% a year ago, while Japan and Korea have seen a decline from 46.3% to 44.9%.
Consequently, some US auto producers are even planning to skip the traditional summer shutdown at some of their plants to keep up with expected demand. The surge in sales is being underpinned by lease demand. Auto sales only started to recover in 2010 and an estimated 500,000 3-year leases will be expiring this year. And among the major players, competition for this 'up-for-grabs' business is intensifying.
Consumer expectations did take a sharp hit ahead of January's tax changes but have since surged to their highest level since November. Confidence levels are still below pre-crisis levels but renewed optimism about the next 12 months suggests that public spending and tax changes earlier in the year have now been largely absorbed.
What will have helped to sustain confidence and spending is the strong recovery in levels of household net wealth. In the economic and financial crisis of 2008 and its aftermath, housing, stock and other asset prices collapsed. Of those, stock market prices were the first to recover, from the second quarter of 2009, but associated gains in net wealth were concentrated among those in the higher income brackets.
It was only from late 2011 that the recovery in house prices spread the 'wealth' gains to a much wider swathe of the population. These gains have been running at an annual rate of over $1 trillion over the past five quarters. It is now estimated that in Q1, the amount of equity held by consumers in their homes as a proportion of the value of their real estate holdings was the highest since the end of 2007. Even if mortgage rates move higher, levels of affordability still look sufficiently attractive to sustain the housing market recovery and net wealth gains.
In contrast to consumption, industrial production was flat in May, with manufacturing up a paltry 0.1%. Indeed, on a three month basis, manufacturing output fell at an annualised 0.4% in May. As long as the economy continues to show only fitful strength, the Fed is likely to be wary of tightening policy too early.
Europe - Wishful thinking
European leaders appear to have added another gambit to their policy toolkit – wishful thinking. ECB President Draghi has long been foreseeing an economic rebound in the second half of this year. Now French President Hollande has proclaimed that the Euro-zone crisis is over. Of the two soothsayers, Draghi seems the more likely to be proven right. The crisis may have become less virulent of late but the fault lines are still there, the policy options are limited and the region's economic prospects lag behind the rest of the developed economic world.
What is certainly improving is the level of industrial activity. Output in the region as a whole rose for a third successive month in April, by 0.4%. Even if the last two months in the quarter see flat growth, output would be up by over 1.0%, which would very likely end the run of quarterly GDP declines. Recent floods in central Europe, though, could hit output levels.
The uptick in activity has not been broad-based, with output levels in April falling in Italy, Spain, Greece and Portugal. However, there was a reassuring rebound of 2.3% in French industrial production, which took it to a level 2% above its Q1 average. That could well be enough to cement GDP expansion in Q2. Restoration of growth to Europe's 'big two' would help to underpin growth prospects elsewhere in the region.
In contrast, Italy, the Euro-zone's third largest economy, saw another fall in industrial activity over the month. Some forecasters are reducing their GDP forecasts for the year and expect a weaker rebound in 2014. While household spending declines have been diminishing, investment spending declines have been rising. Construction spending has been especially weak, down 4.0% on the quarter.
The economy is, however, in line for a boost from a partial liquidation of state arrears which is scheduled to start this month. These are, in essence, unpaid bills and the total is estimated at around €90 billion or 6% of GDP. One of the last actions of the previous Monti administration was to earmark €40 billion, or 2.5% of GDP, for payment over the next 18 months. Similar exercises in Spain and Greece had a notable impact on their respective economies. For Italy, the authorities are expecting a boost of just over 0.5% in 2013 GDP and almost 1.0% in 2014, although outside observers expect more of an impact.
One reason why Europe's economic prospects lag the likes of the US is the sharp contrast in how companies raise finance. Despite efforts to diversify, bank loans still account for some 80% of Europe's corporate financing. In the US, the figure is more like 20%. That continued reliance on banks will continue to dampen a recovery in the region and should increase efforts to develop other lines of credit availability. For now, though, economic growth prospects remain vulnerable.
Asia-Pacific - Policy challenges out east
The success, or otherwise, of the Abe government's grand plan for the economy will depend on an awful lot of things going right. But it will also depend on the ability of the government to maintain popular support for its policies and for these policies to maintain credibility. The fact that GDP growth in Q1 was revised up to 1.0% from 0.9% tells us little about the likely overall success of Abenomics.
Support for the government's policies appears to have peaked, at least for now, although the declines so far have generally been modest. The prime minister's popularity rate is off a touch, while the Economy Watchers' current conditions judgement fell for a second month. The important point here, however, is that both levels remain high. Further slippage, though, would be a worry. Of more concern are poll findings that as few as 20% of companies expect to benefit from the weak yen policy thrust.
And there is a certain credibility doubt about the weak yen initiative. Asset purchases are supposed to contribute towards a weaker yen, inflationary pressure and a restoration of economic growth. The problem is that because Japanese external assets are over 60% of GDP, a weaker yen boosts income flows from these assets. The April current account surplus in seasonally-adjusted terms rose from ¥342 billion to ¥852 billion, with the income surplus at almost ¥2 trillion, a record. So, even if the policy was initially successful, there would be limits to how far the currency could be weakened.
General public support will be essential, but so too will be support from bond-holders to ensure that a strong back up in yields does not abort any recovery. How the authorities accomplish that while trying to generate inflation will be difficult. They also need to keep control over the budget deficit. While a lowering of corporate taxes may be defensible on grounds it might boost investment, recent hints of potential backsliding over the first planned hike in the consumption tax are less defensible – policymakers must keep a lid on the fiscal deficit or risk losing control of yield levels.
For the Chinese authorities, the challenge has been to introduce changes that will take the economy to its next stage of development, while ensuring healthy growth in the meantime. The immediate problem is that the economy is continuing to show signs of slowing. Monthly growth in investment and industrial production was at its slowest in the last six months, aside from the slowdown associated with Chinese New Year.
The general feeling, though, is that the authorities will be reasonably relaxed provided growth does not slide below 7% and the labour market remains relatively healthy. Certainly, industrial output growth at an annualised rate of around 7.5% is still in a comfort zone and the labour market shows none of the weakness it did back in 2008. Electricity output growth, though, was down to around 4% in the year to May, from over 6% in April.
The authorities will be anxious that the growth momentum stabilises soon, as they are facing a dilemma in what to do about surging credit growth. Although it abated somewhat in May, there is still a fear of a re-run of 2008, when rapid credit expansion led to rising levels of bad debt and financial failure. Clamping down harder on credit growth, though, risks slowing the economy even more. They will hope that recent improvements in global growth prospects translate into a pick-up in trade growth.