RECESION MUNDIAL?, RGE MONITOR

A few weeks back we surveyed a group of countries navigating towards (or through) recession. The list included the U.S., Canada, Spain, Ireland, Italy, the UK, the Baltics and New Zealand.

Now the growth engine of the EMU, Germany, is faltering, together with France. And a recession might be in the works for Japan as well. This essentially leaves us with a fully fledged G7 recession in the making.


After a long period of disinflation in the 1980s and 1990s, the rise of G7 inflation poses a dilemma for central bankers who must also grapple with credit crunch and risks of recession. The balance of risks is likely to keep G7 central banks from tightening aggressively, with some staying on hold for the rest of 2008. Others, like Australia and more so New Zealand, who have the luxury of high interest rates to start cutting from will likely loosen policy to stave off recession.

Last week we asked whether the U.S. economy is in recession or not . An official answer to this question is not likely to come anytime soon, but recent reports – GDP and employment in particular – are not auspicious.


U.S. inflation in its various manifestations – PCE deflator, CPI, PPI, import inflation, inflation expectations - is at decade(s) highs and stands outside the Fed's comfort zone. As much of this inflation is driven by a weak dollar and external demand for commodities, rate hikes in the U.S. alone won't stop global inflation (though it may help). Moreover, the still benign trends in inflation and inflation expectations has left the Fed room to worry more about financial stability and a flagging economy at home. According to the consensus, fading stimulus from tax rebates and ongoing housing and financial crises will push back tightening to yearend or next year, however, a worsening of the growth outlook could even prompt the Fed to cut rates in the second half of the year.

While Canada may avoid a technical recession – growth might be barely positive in Q2 after a contraction in Q1- output has been slowing. Buoyant domestic demand, spurred by a sustained terms of trade rise, could also now be fading as Canadian consumers and businesses are feeling the strains. With 75% of Canada ’s exports U.S. bound, it can’t escape a U.S. recession, and its financial links are significant too. Meanwhile housing and labor markets are starting cool. With the disinflationary effect of the Canadian dollar’s strength waning, the Bank of Canada looks to be firmly on hold for now after aggressive easing in H1.

In the UK, despite severe threats of a spike in inflation mostly due to higher food and oil prices, economic activity already shows clear signs of a slowdown. Measures of business and consumer confidence, the deteriorating housing market and the still quite fragile mortgage and credit markets might push the economy into a recession-like environment relatively soon. Surveys on the probability of a recession show an increase in the median forecast from 30% in June to 45% in July?, while many analysts already call for at least one reading of negative growth by the end of the first half of 2009.

UK’s fast-deteriorating inflation outlook has increased speculation of a BoE tightening cycle in the last couple of months. Nonetheless, the BoE will probably hold rates unchanged throughout the year as the economy is set to display much slower growth in the coming quarters. The BoE’s dilemma will most likely persist. So far the spike in CPI (+3.8%) has not affected average earnings, downplaying the case of a wage-price spiral fed by a self-fulfilling cycle of inflationary shocks and worsening expectations.

In the Eurozone economic indicators turned sharply lower after a buoyant Q1 GDP reading that fuelled hopes for a decoupling from the U.S. recession. Whether the ECB 25bp rate hike on July 3rd accelerated the business sentiment downturn or not remains an open question. The fact remains that many analysts now expect a negative Q2 GDP growth reading, and worries about persistently divergent growth paths among EMU members are emerging.

On a country basis, both Germany’s manufacturing and services leading indicators as measured by the PMI Survey point to slow but still expanding activity in July. After a decade of working through its post-reunification housing bust and restoring of corporate balance sheets, Germany finds itself in a relatively balanced macroeconomic position compared to its EMU peers. The combination of falling house prices, high inflation, and higher credit costs is particularly toxic for Spain whose leading indicators are hitting one record low after another. Economic analysts are also starting to sound alarm bells on Spain’s banking sector. Italy is the second laggard in the group of big four EMU countries. The lack of reforms and the continuing loss of competitiveness are clearly taking their toll now. France has seen the sharpest reversal in both consumer and business sentiment in Q2 coinciding with the turning of its housing market.


On the inflation front, headline HICP has been surpassed by its U.S. equivalent – headline CPI. Like in the U.S., core inflation stands outside the ECB's comfort zone. However, unlike the U.S., wage indexation has led to automatic second-round effects, with inflation leading to wage increases in a few Eurozone countries. With a wary eye on a further rise in inflation expectations, the inflation-targeting ECB is the most likely to hike rates among the G7 in the rest of 2008. Some analysts believe one more hike is in store but slowing growth and lower inflation due to base effects in autumn could keep the ECB from that rate hike button.

Is Japan’s longest post-war growth period coming to an end? Most analysts agree Japan is headed for a slowdown, but many expect the world’s second-largest economy to avoid a severe, prolonged slump. There is no doubt that high food and fuel prices are denting domestic consumption, while cooling global demand appears to have stalled Japan’s export growth engine. Nevertheless, Japan’s problems seem relatively minor compared to the U.S. and certain EU countries. It has no house price bubble, its financial sector is basically healthy, and consumer price inflation - while rising - is still under 2.0% yoy.


Japan has only recently exited deflation. So while consumer prices have risen almost 2.0% over the past 12 months and are likely to rise further, core inflation (excluding food and energy) is still barely positive. Consequently, most analysts see little chance of a rate hike for the rest of 2008. As long as wage growth remains sluggish and price gains do not spread to the overall economy, the Bank of Japan is expected to keep the target rate at 0.5%.

What are the implications for the main emerging markets? Between them Brazil, Russia, India and China (the BRICs) contributed about half of global growth in 2007 but they can’t escape a protracted slowing of G7 economies – nor is their consumption large enough to propel global growth and if they slow, so might global commodity demand growth.

Inflation has been a global threat and it is not different for the BRIC economies. The inflation outlook and the responses to the worsening inflation are nonetheless different among those countries. Russia has the highest inflation figures and the least enforcing response, while Brazil has the lowest inflation figures with the most austere monetary policy response. Even though more than 20 Emerging Market central banks are following an inflation targeting regime as a monetary anchor, nearly every country is facing inflation figures above the center of the established target. The worsening of inflation readings in many cases is encouraging a more hawkish policy especially in cases where central banks are already behind the curve or where credibility needs to be boosted.

Brazil’s economic prospects are still favorable as domestic output growth continues underpinned by high business confidence and high commodity prices. So far Brazilian economic growth is expected to continue unabated in 2008. The pace of the expansion in Brazil is bound to be moderated by persistent inflationary pressures, as disposable incomes start to erode and business confidence is dented by tighter credit conditions. Brazil’s consumer prices increased 0.74% during June, taking the twelve-month inflation rate to 6.1%, with the food and drink category increasing 15%. The Brazilian Central Bank increased interest rates by 75bps to 13% in July and possibly more hikes will come soon to curb inflation.

Inflation is now eating away at Russia’s oil-fuelled consumption growth with the recent data showing flat real wage growth, slowing construction, retail sales and investment – suggesting growth will slow in the second half of 2008. Meanwhile Russia’s human and physical capital constraints are real – planned infrastructure investment hopes to make up for decades of under investment. Yet, 10 years after its financial crisis, Russia is in a much sounder financial position, having amassed $500 billion in foreign exchange reserves. With growth likely to slow and productivity low, the central bank is reluctant to engage in real monetary tightening, lest it bring a return of the liquidity problems it faced earlier this year or slow growth. Despite raising interest rates four times this year, interest rates remain very negative in real terms, likely contributing to the frothy Moscow office market.

After the stellar 9%-plus growth in 2006-07, India’s 2008 growth forecast has been lowered to 7-8%. In spite of being labeled as a domestic-demand driven economy resilient to global slowdown, the recent investment boom and above-potential growth were buoyed by imports and benign global liquidity conditions. Global financial turmoil and oil price shock have exposed India ’s vulnerability to capital outflows and financing of twin deficits, posing the risk of asset market correction and currency depreciation even as domestic demand trends down on high inflation. India’s double-digit inflation running at a 13-year high is led by food shortages, commodity prices and government’s reduction of oil subsidies. But inflation risk is exacerbated by strong domestic demand and liquidity fueled by pre-election fiscal spending, credit growth and incomplete sterilization of capital inflows. Price controls, trade restrictions and ban on futures trading have only angered the private sector. After a series of interest rate hikes, further tightening is constrained by risks to demand slowdown so that only an easing of global commodity prices may be a blessing.

China’s growth has been decelerating for the past four quarters to reach just over 10% in Q2. While private consumption is now contributing a bit more to growth (though investment is still the biggest driver) and incomes are on the rise, inventory pileups could indicate overcapacity in some sectors. Exports to Europe , which marked double digit growth last year are now falling, manufacturing output seems to be contracting and exporters are complaining of higher labor and input costs. With a focus on growth, and headline inflation stabilized, the Chinese government is shifting away from its ‘tight’ monetary policy – some lending curbs have been lifted and RMB appreciation has already stalled. See “ Chinese Economic Outlook: China's Triple Threat of Slowing Growth, Inflation and Falling Asset Markets” and Rachel Ziemba’s “Is China Suffering an Olympic Shock?”

RECESION MUNDIAL?, RGE MONITOR

A few weeks back we surveyed a group of countries navigating towards (or through) recession. The list included the U.S., Canada, Spain, Ireland, Italy, the UK, the Baltics and New Zealand.

Now the growth engine of the EMU, Germany, is faltering, together with France. And a recession might be in the works for Japan as well. This essentially leaves us with a fully fledged G7 recession in the making.


After a long period of disinflation in the 1980s and 1990s, the rise of G7 inflation poses a dilemma for central bankers who must also grapple with credit crunch and risks of recession. The balance of risks is likely to keep G7 central banks from tightening aggressively, with some staying on hold for the rest of 2008. Others, like Australia and more so New Zealand, who have the luxury of high interest rates to start cutting from will likely loosen policy to stave off recession.

Last week we asked whether the U.S. economy is in recession or not . An official answer to this question is not likely to come anytime soon, but recent reports – GDP and employment in particular – are not auspicious.


U.S. inflation in its various manifestations – PCE deflator, CPI, PPI, import inflation, inflation expectations - is at decade(s) highs and stands outside the Fed's comfort zone. As much of this inflation is driven by a weak dollar and external demand for commodities, rate hikes in the U.S. alone won't stop global inflation (though it may help). Moreover, the still benign trends in inflation and inflation expectations has left the Fed room to worry more about financial stability and a flagging economy at home. According to the consensus, fading stimulus from tax rebates and ongoing housing and financial crises will push back tightening to yearend or next year, however, a worsening of the growth outlook could even prompt the Fed to cut rates in the second half of the year.

While Canada may avoid a technical recession – growth might be barely positive in Q2 after a contraction in Q1- output has been slowing. Buoyant domestic demand, spurred by a sustained terms of trade rise, could also now be fading as Canadian consumers and businesses are feeling the strains. With 75% of Canada ’s exports U.S. bound, it can’t escape a U.S. recession, and its financial links are significant too. Meanwhile housing and labor markets are starting cool. With the disinflationary effect of the Canadian dollar’s strength waning, the Bank of Canada looks to be firmly on hold for now after aggressive easing in H1.

In the UK, despite severe threats of a spike in inflation mostly due to higher food and oil prices, economic activity already shows clear signs of a slowdown. Measures of business and consumer confidence, the deteriorating housing market and the still quite fragile mortgage and credit markets might push the economy into a recession-like environment relatively soon. Surveys on the probability of a recession show an increase in the median forecast from 30% in June to 45% in July?, while many analysts already call for at least one reading of negative growth by the end of the first half of 2009.

UK’s fast-deteriorating inflation outlook has increased speculation of a BoE tightening cycle in the last couple of months. Nonetheless, the BoE will probably hold rates unchanged throughout the year as the economy is set to display much slower growth in the coming quarters. The BoE’s dilemma will most likely persist. So far the spike in CPI (+3.8%) has not affected average earnings, downplaying the case of a wage-price spiral fed by a self-fulfilling cycle of inflationary shocks and worsening expectations.

In the Eurozone economic indicators turned sharply lower after a buoyant Q1 GDP reading that fuelled hopes for a decoupling from the U.S. recession. Whether the ECB 25bp rate hike on July 3rd accelerated the business sentiment downturn or not remains an open question. The fact remains that many analysts now expect a negative Q2 GDP growth reading, and worries about persistently divergent growth paths among EMU members are emerging.

On a country basis, both Germany’s manufacturing and services leading indicators as measured by the PMI Survey point to slow but still expanding activity in July. After a decade of working through its post-reunification housing bust and restoring of corporate balance sheets, Germany finds itself in a relatively balanced macroeconomic position compared to its EMU peers. The combination of falling house prices, high inflation, and higher credit costs is particularly toxic for Spain whose leading indicators are hitting one record low after another. Economic analysts are also starting to sound alarm bells on Spain’s banking sector. Italy is the second laggard in the group of big four EMU countries. The lack of reforms and the continuing loss of competitiveness are clearly taking their toll now. France has seen the sharpest reversal in both consumer and business sentiment in Q2 coinciding with the turning of its housing market.


On the inflation front, headline HICP has been surpassed by its U.S. equivalent – headline CPI. Like in the U.S., core inflation stands outside the ECB's comfort zone. However, unlike the U.S., wage indexation has led to automatic second-round effects, with inflation leading to wage increases in a few Eurozone countries. With a wary eye on a further rise in inflation expectations, the inflation-targeting ECB is the most likely to hike rates among the G7 in the rest of 2008. Some analysts believe one more hike is in store but slowing growth and lower inflation due to base effects in autumn could keep the ECB from that rate hike button.

Is Japan’s longest post-war growth period coming to an end? Most analysts agree Japan is headed for a slowdown, but many expect the world’s second-largest economy to avoid a severe, prolonged slump. There is no doubt that high food and fuel prices are denting domestic consumption, while cooling global demand appears to have stalled Japan’s export growth engine. Nevertheless, Japan’s problems seem relatively minor compared to the U.S. and certain EU countries. It has no house price bubble, its financial sector is basically healthy, and consumer price inflation - while rising - is still under 2.0% yoy.


Japan has only recently exited deflation. So while consumer prices have risen almost 2.0% over the past 12 months and are likely to rise further, core inflation (excluding food and energy) is still barely positive. Consequently, most analysts see little chance of a rate hike for the rest of 2008. As long as wage growth remains sluggish and price gains do not spread to the overall economy, the Bank of Japan is expected to keep the target rate at 0.5%.

What are the implications for the main emerging markets? Between them Brazil, Russia, India and China (the BRICs) contributed about half of global growth in 2007 but they can’t escape a protracted slowing of G7 economies – nor is their consumption large enough to propel global growth and if they slow, so might global commodity demand growth.

Inflation has been a global threat and it is not different for the BRIC economies. The inflation outlook and the responses to the worsening inflation are nonetheless different among those countries. Russia has the highest inflation figures and the least enforcing response, while Brazil has the lowest inflation figures with the most austere monetary policy response. Even though more than 20 Emerging Market central banks are following an inflation targeting regime as a monetary anchor, nearly every country is facing inflation figures above the center of the established target. The worsening of inflation readings in many cases is encouraging a more hawkish policy especially in cases where central banks are already behind the curve or where credibility needs to be boosted.

Brazil’s economic prospects are still favorable as domestic output growth continues underpinned by high business confidence and high commodity prices. So far Brazilian economic growth is expected to continue unabated in 2008. The pace of the expansion in Brazil is bound to be moderated by persistent inflationary pressures, as disposable incomes start to erode and business confidence is dented by tighter credit conditions. Brazil’s consumer prices increased 0.74% during June, taking the twelve-month inflation rate to 6.1%, with the food and drink category increasing 15%. The Brazilian Central Bank increased interest rates by 75bps to 13% in July and possibly more hikes will come soon to curb inflation.

Inflation is now eating away at Russia’s oil-fuelled consumption growth with the recent data showing flat real wage growth, slowing construction, retail sales and investment – suggesting growth will slow in the second half of 2008. Meanwhile Russia’s human and physical capital constraints are real – planned infrastructure investment hopes to make up for decades of under investment. Yet, 10 years after its financial crisis, Russia is in a much sounder financial position, having amassed $500 billion in foreign exchange reserves. With growth likely to slow and productivity low, the central bank is reluctant to engage in real monetary tightening, lest it bring a return of the liquidity problems it faced earlier this year or slow growth. Despite raising interest rates four times this year, interest rates remain very negative in real terms, likely contributing to the frothy Moscow office market.

After the stellar 9%-plus growth in 2006-07, India’s 2008 growth forecast has been lowered to 7-8%. In spite of being labeled as a domestic-demand driven economy resilient to global slowdown, the recent investment boom and above-potential growth were buoyed by imports and benign global liquidity conditions. Global financial turmoil and oil price shock have exposed India ’s vulnerability to capital outflows and financing of twin deficits, posing the risk of asset market correction and currency depreciation even as domestic demand trends down on high inflation. India’s double-digit inflation running at a 13-year high is led by food shortages, commodity prices and government’s reduction of oil subsidies. But inflation risk is exacerbated by strong domestic demand and liquidity fueled by pre-election fiscal spending, credit growth and incomplete sterilization of capital inflows. Price controls, trade restrictions and ban on futures trading have only angered the private sector. After a series of interest rate hikes, further tightening is constrained by risks to demand slowdown so that only an easing of global commodity prices may be a blessing.

China’s growth has been decelerating for the past four quarters to reach just over 10% in Q2. While private consumption is now contributing a bit more to growth (though investment is still the biggest driver) and incomes are on the rise, inventory pileups could indicate overcapacity in some sectors. Exports to Europe , which marked double digit growth last year are now falling, manufacturing output seems to be contracting and exporters are complaining of higher labor and input costs. With a focus on growth, and headline inflation stabilized, the Chinese government is shifting away from its ‘tight’ monetary policy – some lending curbs have been lifted and RMB appreciation has already stalled. See “ Chinese Economic Outlook: China's Triple Threat of Slowing Growth, Inflation and Falling Asset Markets” and Rachel Ziemba’s “Is China Suffering an Olympic Shock?”