Goings on in the world's major economies
With the recent volatility taking place in the global markets, it is opportune to take a closer look at what is happening in the world's major economies. The United States In the US, the financial turmoil that led to the 50 basis points Fed easing...
With the recent volatility taking place in the global markets, it is opportune to take a closer look at what is happening in the world's major economies.
The United States
In the US, the financial turmoil that led to the 50 basis points Fed easing last month has created uncertainties about the economic damage it will exact. The situation appears binary. Either the liquidity crunch is resolved successfully and the economy is fine, in which case the Fed may need to tighten policy in about six months time, or a full blown credit crunch develops, where lending standards are tightened severely and recession follows. In this scenario, the unemployment rate would rise to over 6 per cent, and the Fed would slash interest rates to 2 per cent -3 per cent.
For now, however, evidence of economic damage, outside of housing, still appears quite limited. Typically, one would see bigger rises in initial jobless claims and the unemployment rate, together with more sizable declines in consumer confidence and the ISM manufacturing survey, to be consistent with persistent sogginess in economic conditions.
Still, there are vulnerabilities. Around three-quarters of job growth this year has come from just four sectors: government; education; health; and restaurants, hardly a sign of broad based strength. So far, 2007 GDP forecasts have been kept at 2 per cent and lowered to 2.4 per cent for 2008. Consumption is set to slow in 2008 to 2.2 per cent, while housing will continue to fall. Business investment should record modest gains, while exports should remain buoyant. Core inflation should stay a touch below the Fed's 2 per cent implied ceiling.
The eurozone
The European Central Bank (ECB) faces an unusually difficult task in the coming months. Prior to the recent financial market turmoil a further 50 basis points of tightening was envisaged on the back of slightly above-trend growth, a further fall in unemployment and the fear that inflation expectations could move higher as headline inflation moved easily above 2 per cent. However, although inflation fears persist, the seizure in money markets kept the ECB on hold at last month's meeting. It is now believed that interest rates have peaked and the first rate cut is highly dependent on how long 3 month money rates remain at the current level of 4.75 per cent.
With inflation set to move up to 2.3 per cent or more in the next few months, the ECB is likely to continue to sound hawkish until there are conclusive signs that the current re-pricing of risk is impacting the real economy significantly. Even if money markets normalise to some degree, lending standards seem set to tighten, leading to a slowdown in private sector credit growth.
The annual average GDP growth forecast for 2008 has been lowered to 1.9 per cent reflecting a weaker outlook for the domestic economy and exports. As inflation is unlikely to move below 2 per cent until the second quarter of 2008, and even then only slightly, a 25 basis points rate cut is probable around mid next year.
The United Kingdom
In the UK this year, weak wage and employment growth and 125 basis points of rate hikes have done little to dent the optimism and spending of the consumer. The stimulus appeared to be coming from the banking sector. Spreads on loans to households and corporates were narrowed and credit conditions loosened. For example, on mortgages, rather than passing on rate increases, many banks charged fees of up to £2,000 which were then added to the mortgage debt, deferring payment. Hence, the BoE had to tighten interest rates more than previously anticipated.
During the recent financial turmoil, banks, and often the main mortgage lenders, have had serious financing difficulty. One bank needed to resort to the BoE for emerging funding, the publication of which led to the first bank run since the 1860s. Following this, households and corporates are fully aware of the problems in the banking sector. This should force a reassessment of willingness to spend and take on debt. A sharp slowdown in consumer and investment spending is expected going into 2008. When there are signs of this, the BoE will probably cut rates in the first quarter of 2008.
Japan
Japan's real GDP fell 1.2 per cent in the second quarter of 2007, mainly due to falling capital expenditure. This was mainly a reaction after very high growth rates in the previous quarters. Against this backdrop, 2008 GDP growth forecasts have been revised down to 1.8 per cent, as some slowdown in exports and capital investment is expected in response to weaker US growth following the sub-prime problems. However, exports to emerging countries should remain firm.
Based on the capital stock cycle, a slowdown in private capital investment is foreseen, primarily in investment in information technology. However, in the second half of 2008, private capital investment is likely to pick-up, based on strong external demand. As long as corporate profits continue to grow, personal consumption is likely to increase steadily.
Japan's core inflation is expected to fall by 0.1 per cent in 2007, as oil product prices remain below previous year levels. In addition, service prices are unlikely to rise, given the downturn in wages per worker. The Bank of Japan is expected to raise rates by 25 basis points in the first quarter of 2008, as policymakers wait for market stability to return and try to assess the impact of sub-prime problems upon the US economy.
• This report was compiled by Peter Calleya, Manager Corporate Strategy & Research, HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.
The United States
In the US, the financial turmoil that led to the 50 basis points Fed easing last month has created uncertainties about the economic damage it will exact. The situation appears binary. Either the liquidity crunch is resolved successfully and the economy is fine, in which case the Fed may need to tighten policy in about six months time, or a full blown credit crunch develops, where lending standards are tightened severely and recession follows. In this scenario, the unemployment rate would rise to over 6 per cent, and the Fed would slash interest rates to 2 per cent -3 per cent.
For now, however, evidence of economic damage, outside of housing, still appears quite limited. Typically, one would see bigger rises in initial jobless claims and the unemployment rate, together with more sizable declines in consumer confidence and the ISM manufacturing survey, to be consistent with persistent sogginess in economic conditions.
Still, there are vulnerabilities. Around three-quarters of job growth this year has come from just four sectors: government; education; health; and restaurants, hardly a sign of broad based strength. So far, 2007 GDP forecasts have been kept at 2 per cent and lowered to 2.4 per cent for 2008. Consumption is set to slow in 2008 to 2.2 per cent, while housing will continue to fall. Business investment should record modest gains, while exports should remain buoyant. Core inflation should stay a touch below the Fed's 2 per cent implied ceiling.
The eurozone
The European Central Bank (ECB) faces an unusually difficult task in the coming months. Prior to the recent financial market turmoil a further 50 basis points of tightening was envisaged on the back of slightly above-trend growth, a further fall in unemployment and the fear that inflation expectations could move higher as headline inflation moved easily above 2 per cent. However, although inflation fears persist, the seizure in money markets kept the ECB on hold at last month's meeting. It is now believed that interest rates have peaked and the first rate cut is highly dependent on how long 3 month money rates remain at the current level of 4.75 per cent.
With inflation set to move up to 2.3 per cent or more in the next few months, the ECB is likely to continue to sound hawkish until there are conclusive signs that the current re-pricing of risk is impacting the real economy significantly. Even if money markets normalise to some degree, lending standards seem set to tighten, leading to a slowdown in private sector credit growth.
The annual average GDP growth forecast for 2008 has been lowered to 1.9 per cent reflecting a weaker outlook for the domestic economy and exports. As inflation is unlikely to move below 2 per cent until the second quarter of 2008, and even then only slightly, a 25 basis points rate cut is probable around mid next year.
The United Kingdom
In the UK this year, weak wage and employment growth and 125 basis points of rate hikes have done little to dent the optimism and spending of the consumer. The stimulus appeared to be coming from the banking sector. Spreads on loans to households and corporates were narrowed and credit conditions loosened. For example, on mortgages, rather than passing on rate increases, many banks charged fees of up to £2,000 which were then added to the mortgage debt, deferring payment. Hence, the BoE had to tighten interest rates more than previously anticipated.
During the recent financial turmoil, banks, and often the main mortgage lenders, have had serious financing difficulty. One bank needed to resort to the BoE for emerging funding, the publication of which led to the first bank run since the 1860s. Following this, households and corporates are fully aware of the problems in the banking sector. This should force a reassessment of willingness to spend and take on debt. A sharp slowdown in consumer and investment spending is expected going into 2008. When there are signs of this, the BoE will probably cut rates in the first quarter of 2008.
Japan
Japan's real GDP fell 1.2 per cent in the second quarter of 2007, mainly due to falling capital expenditure. This was mainly a reaction after very high growth rates in the previous quarters. Against this backdrop, 2008 GDP growth forecasts have been revised down to 1.8 per cent, as some slowdown in exports and capital investment is expected in response to weaker US growth following the sub-prime problems. However, exports to emerging countries should remain firm.
Based on the capital stock cycle, a slowdown in private capital investment is foreseen, primarily in investment in information technology. However, in the second half of 2008, private capital investment is likely to pick-up, based on strong external demand. As long as corporate profits continue to grow, personal consumption is likely to increase steadily.
Japan's core inflation is expected to fall by 0.1 per cent in 2007, as oil product prices remain below previous year levels. In addition, service prices are unlikely to rise, given the downturn in wages per worker. The Bank of Japan is expected to raise rates by 25 basis points in the first quarter of 2008, as policymakers wait for market stability to return and try to assess the impact of sub-prime problems upon the US economy.
• This report was compiled by Peter Calleya, Manager Corporate Strategy & Research, HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.