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

1. The Global Economy
Monthly letter from Swedbank’s Economic Research Department
by 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 isn't 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 second
Economic data released this spring and summer by
quarter. This is the weakest rate in three years. If
the US, Asia and Europe have been mixed with a
quarterly statistics are to be believed, growth
bias on the downside. GDP numbers for the second
improved from 1.6% to 1.8% in seasonally adjusted
quarter have not been finalised, but most of the
terms. One way or another, there is little doubt that
countries that have published their data reported
China is in a period of weak development. Industrial
shrinking economic activity or slower growth. All
and electricity production as well as housing are
indications 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 monetary
Studying the Purchasing Managers Index (PMI) for conditions have eased. Lending won’t have the
industry 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 riskier
The situation is most acute in the euro area, where and politicians and companies are both being more
the 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 last
below 50 for the second consecutive month.
quarter of 2011 and 0.5% in the first quarter this
Although China’s purchasing managers still expect
year to 0.4% in the second quarter. Weak income
a 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: ek.sekr@swedbank.se Internet: www.swedbank.com Responsible publisher: Cecilia Hermansson, +46-8-
5859 7720, Magnus Alvesson, +46-8-5859 3341, Jörgen Kennemar, +46-8-5859 7730, ISSN 1103-4897

2. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 5 • 7 August 2012
fallen. Uncertainty about the government’s budget GDP fell by 0.3% in the last quarter of 2011 and the
will increasingly impact growth prospects, with GDP first quarter this year. The decline was expected
potentially 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. After
to spend and businesses to invest and hire is receiving €100 billion to shore up its banks, the
probably already being affected this year. focus has shifted to Spain’s regions’ reluctance
towards meeting demands to reduce deficits. Spain
Purchasing Managers Index (PMI) for various won’t be able to handle 10-year bond yields near
countries/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
120
After a spring with weak job numbers in the US, the
July results were a positive surprise with a total of 115
163 000 new jobs created, including 172 000 in the 110
private sector at the same time that the public 105
sector lost 9 000. In spite of this, unemployment
100
inched up from 8.2% to 8.3%. One reason may be
that different surveys that serve as a basis for the 95
Index
two types of data. A larger labour supply also 90
Germany
caused unemployment to rise. The current US 85 Euro area
growth rate is enough to stabilise unemployment, Spain
80 Greece
but not to significantly reduce it, which is a major
75
problem for the administration leading up to the
presidential election in November. 70
65
A positive factor are the green shoots in the 05 06 07 08 09 10 11 12
housing market, where housing starts are rising Source: Reuters EcoWin
from a low level, sales of existing homes have
increased 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 to
There are still many available homes on the market mention at an accelerating rate, from 0.4% and
and foreclosures are affecting prices, but the 0.3% in the two previous quarters to 0.7% in the
market appears to have bottomed out. This doesn’t second quarter. Blame has been placed on the
mean, however, that prices will rise quickly. The weather and the Queen's Diamond Jubilee, a
housing market won’t be able to provide enough national holiday, but the fact remains that the UK is
growth when fiscal and euro area developments are in recession. The Olympics probably won't have
holding back economic activity. much of an effect, since the country at the same
time lost its ordinary tourists.
In Europe, preliminary GDP numbers will be
published on August 14, with a second, more Criticism against the government has grown, since
reliable estimate due on September 6. Spain noted the budget consolidation is constraining domestic
a 0.4% quarterly decline in the second quarter after demand. At the same time the UK is being hurt by
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3. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 5 • 7 August 2012
slower demand from the euro area. The The problem is that looser monetary policy won't do
government will have to ease up on austerity if the much to alleviate the euro zone’s growing real
recession worsens, but at the same time would lose economic and financial burden as well as the
face. It can still be claimed that the labour market is worrying fragmentation of financial markets. It
performing more positively than growth data makes sense to further cut interest rates, but the
suggest. In the last two years employment has risen focus is and should be on more unconventional
by 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 of
means 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 approach
to 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 8
government, while in Spain's case the euro area
also has a say. Lending costs in the UK are very 7
low, and if medium-term policy is correctly
communicated it could maintain the confidence of
6
the financial market even if the pace of
consolidation slows. The ECB could further cut its
Percent
benchmark rate and develop quantitative easing. 5
The UK, US and Japan are likely to expand
monetary stimulus programmes by buying 4
government bonds or other assets in the second-
hand market. The effects on growth won’t be great, 3
however, even if it makes stock traders and others 2 yr government bond
in the financial market happy – temporarily. 10 yr government bond
2
jan mar maj jul sep nov jan mar maj jul
ECB ties bond-buying to ESM – is that 11 12
Source: Reuters EcoWin
enough?
The recession is worsening in the euro area and From at least one perspective ECB President Mario
unemployment continues to rise in several Draghi’s latest speech seems to have made a
countries. In July unemployment stabilised at difference: two-year bond yields have turned lower
11.2%, but is likely to continue to trend higher. At (see diagram above). This is because the ECB has
the same time inflation is slowing. In July it was announced it will buy bonds with shorter maturities
down to 2.4%, from just over 3% at the end of last from countries that have applied to the EFSF/ESM
year. The ECB expects inflation to fall below 2% programme and had the terms for such support
next 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 up
Unemployment (%) 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 it
Percent
could be stigmatising to seek support. Spain hasn't
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
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4. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 5 • 7 August 2012
short-term maturities also poses a risk, since the It doesn't make much sense really to lump all
loans often have to be rolled over. The question of emerging countries together given the different
seniority – whether or not the ECB takes conditions they face. Several Latin American
precedence over private creditors in the event of a countries have little savings and weak productivity
debt reconstruction – will also be taken up by the growth, while China has exceedingly high savings
working groups now drafting the plan. and is maintaining good productivity growth. In
China's case capacity has been expanded quickly,
The ECB could complement the bond-buying which could lead to overcapacity if demand from the
programme now being drafted with new fixed-rate West shrinks even more. India and Brazil are
loans at low interest rates (LTRO), amended rules dealing with capacity shortages after several years
on collateral, negative interest rates on deposits of insufficient investment, which means that rate
with the ECB, etc. It isn’t likely, however, that Spain cuts could be one (perhaps risky) way to stimulate
and Italy will be helped much. They may need the growth, since potential growth may have fallen,
“bazooka” Draghi talked about, but which doesn't which could quickly lead to overheating.
yet exist. The ESM hasn’t been approved by the
German constitutional court and a decision isn’t Although conditions differ, there is reason to ask
expected until September 12, which will include its whether potential growth for this group of countries
opinion whether the ESM should receive a banking will change if the West undergoes an acid test and
license that expands its lending capability. faces major challenges for years to come.
Germany's view on the way ECB prefer going
forward is still unclear. The government seem to One possible change for emerging countries is if
endorse it, while Bundesbank is hesitating. investors’ risk appetite weakens and capital inflows
shrink. They could in fact change direction, which
If 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 emerging
market and/or with a banking license, it would be a countries that are dependent on commodity exports
step 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 on
because they are implementing reforms. This is commodity imports and to date have subsidised
only reasonable, but the problem is that it could be energy consumption, which has a major negative
an awfully slow political process and the self- impact on their budgets, will benefit.
fulfilling rise in yields that we have already seen in
the bond market could continue, not only The US, Japan and Europe will have to implement
threatening the stability of Spain and Italy but also a number of structural reforms to meet the
of Europe as a whole and the global economy. challenges in the years ahead. The same applies to
emerging countries, even if they don't have a “knife
Emerging countries – is potential growth at their throats”. Their own imbalances will come to
lower now? the surface when trade and capital inflows (and
growth) no longer come automatically. For countries
Nearly 80% of growth in the global economy is
that are “sitting on their hands”, potential growth is
being generated by emerging countries. This figure
likely to decline in the years ahead, if it hasn't
will only gradually shrink to 70% in the years ahead,
already.
which makes the West highly dependent on the
continued development of emerging economies. Cecilia Hermansson
Swedbank
Economic 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 preparation
SE-105 34 Stockholm, Sweden
of the analyses reported in this publication. However, we cannot guarantee the accuracy or
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Cecilia Hermansson, +46-88-5859 7720. monthly The Global Economy newsletter.
Magnus Alvesson, +46-8-5859 3341
Jörgen Kennemar, +46-8-5859 7730
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