Monday, September 15, 2014

Forecast risk to China growth shifts to the downside

Only two months ago it looked like the risks to 2014 expected growth in China of 7.5% had shifted to the upside.  While I try not to read too much into monthly data, generally weak August activity data suggests the risks have now shifted to the downside.

Industrial production, fixed asset investment and retail sales all came in weaker than expect in August.  That followed release a few days ago of trade data showing that export growth had slipped from 14.5% in July to 9.4% in August, although at the time of the release of the July data we thought it looked too strong.

Negative monthly growth in industrial production and the decline in the annual rate of growth from 9.0% yoy in July to 6.9% in August is the most disconcerting element.  This appears to be related to the slowdown in the property market with annual rates of growth in the production of steel, cement, glass and household appliances such as washing machines all lower over the month.  In that respect a slowdown is perhaps not surprising.  However to put a monthly decline in IP into perspective there were only 3 such months during the GFC and only one other since, so this is an unusual occurrence.

Retail sales and fixed asset investment were also weaker than expected, although the annual growth of real retail sales ticked higher from 10.4% to 10.6%.  However sales of home appliances and furniture posted lower annual rates of growth over the moth which fits with the property slowdown story.  Sales of these items will likely remain a drag on growth in overall retail spending for the foreseeable future.

Manufacturing, infrastructure and property fixed asset investment all slowed over the month with the overall rate of year-to-date growth slowing from 17.0% for the period to July to 16.5% in the period to August.  Infrastructure had been holding up well on the back of stimulus and appears a likely candidate for more should activity continue to surprise to the downside.  The good news is the slide in property investment appears to be slowing.

After GDP growth surprised on the upside in the first half of the year, the risks to growth have again moved to the downside.  We had 7.4% penciled in for Q3.  While that looks optimistic now in light of the low IP result, export growth is running stronger than we thought it would at this point.

The Government appeared to take its foot off the stimulus pedal following the stronger data up to June.  We think we will see efforts to stabilize growth step up again.  Indeed the monetary authorities appear comfortable with the lower interbank rate over the last few weeks.  We also expect increased fiscal spending will be used should the government want to increase cyclical support for the economy along with further targeted reductions in the required reserve ratio.

Thursday, September 11, 2014

RBNZ on hold until next year

As was universally anticipated the Reserve Bank of New Zealand left the Official Cash rate unchanged today.  Having flagged a “period of assessment” following the last 25bp hike in July, the focus has been on how long a pause would ensue and how much more tightening the RBNZ thought was now warranted.

There were no surprises in the assessment of the factors during the economy at the moment.  The RBNZ sees growth continuing to be supported by increasing construction activity, ongoing strength in consumption and business investment with the high level of the net migration also adding to domestic demand.  But the RBNZ sees growth moderating in response to the recent decline in commodity prices and policy tightening.  That said, their forecasts of economic growth are largely unchanged from the June MPS.

As we have come to expect the exchange rate came in for special mention with the RBNZ commenting that it is yet to adjust materially to lower commodity prices and repeating the view that its current level remains unjustified and unsustainable.

The RBNZ acknowledges that the economy is adjusting to the steps they have taken over the past year.  They also acknowledge that house price inflation continues to ease and that CPI inflation remains moderate.   Indeed the change to the Bank’s interest rate projections appears more a reassessment of inflationary pressures than changes to the growth outlook.

However, like us they also believe that spare capacity is being absorbed and that non-tradeables inflation will increase.  That will require further policy adjustment in time.

Interest rate projections appear (it’s always a tad blurred!) to envisage a resumption of the tightening cycle in June next year, with a peak in the 90-day bill rate of 4.8% in mid -2017.  That’s broadly in line with the projections in our latest edition of New Zealand Insights where we expected the RBNZ would be on hold till March next year with an OCR peak of 4.5%, although we expect the Bank will get there more quickly by early 2016.

Friday, September 5, 2014

ECB announces asset purchase program and cuts rates

The European Central Bank did more than I thought they would last night.  In cutting interest rates and embarking on  a plan to purchase asset backed securities from banks, the Governing Council has now done everything it can short of large scale purchases of sovereign bonds.  But will it be enough?

The ECB cut its key interest rates 10bps, taking the refinancing rate to 0.05% and the deposit rate to -0.2%.  In the Press conference Draghi said this move was to give bidders in next week’s TLTRO (September 18) confidence that interest rates would fall no further, thereby reducing the risk of a low take-up.  Apart from that, interest rate reductions are now largely symbolic and will do nothing to improve what fundamentally ails the Euro zone economy.

The ECB also announced two private sector asset purchase programs – the first aimed at asset-backed securities and the second covered bonds.  There was scant detail on likely size or duration of the program.  What we do know is purchases will be limited by the relatively modest size of the Eurosystem’s balance sheet of around €2.1 trillion (10% of Euro zone GDP).

Will this be enough?  That depends on what you mean by “enough”.  It’s enough if the ECB was looking to send a strong message about the intention to meet their inflation objective.  But in our view it’s not enough to alter the outlook of weak growth (our Euro zone GDP forecasts 0.8% this year, 1.2% next year) and a persistent undershoot of the central bank’s inflation target.

In Draghi’s own words from his recent speech at Jackson Hole “No amount of fiscal or monetary accommodation, however, can compensate for the necessary structural reforms in the Euro area”.  One of the key measures of success of this action will be the extent to which respective member state Government’s take the opportunity of the ECB  buying them a bit more time to get on with the job of structural reform.

After today there is only one step left for the ECB: large scale purchases of public sector assets.  They will clearly want to give today’s announcements (and indeed those announced in June) time to work.  The December meeting will be critical as that is when the Governing Council will receive the next set of Staff projections for economic growth and inflation.   

Wednesday, August 27, 2014

Draghi's "call to action"

Much of the discussion around  European Central Bank president Mario Draghi’s speech at the recent Economic Symposium at Jackson Hole has centered on the extent to which it was – or wasn’t – dovish.  I think it was undeniably dovish but dovish within the harsh reality that there is only so much monetary policy can do.  I think the speech is better described as an important “call to action” for a helping hand from fiscal policy and structural reform.

Since the Global Financial Crisis, and with respect to the Euro zone the sovereign debt crisis also, I’ve made a number of observations from time to time about the challenges of raising potential growth rates that were damaged through the Great Recession.  Foremost amongst those observations is the fact (yes, fact) that improving potential growth is predominantly a structural issue.  The role for monetary policy is to support demand and, where necessary buy time for the more important structural reforms to be implemented.

The challenges in the Euro zone are unique and more problematic to the extent that that necessary improvement in external competitiveness in many countries, notably “the periphery” has been constrained by a fixed exchange rate.  That means the adjustment has had to come via wages and employment.  High rates of youth unemployment in many Euro zone economies will ultimately prove to be one of the biggest social crises of our time.  Melodramatic?  I don’t think so.

Progress has been made in reducing large structural budget deficits but at considerable economic cost.  Debt  to GDP ratios have a numerator and a denominator.  Harsh front –loaded austerity measures have thus far done more to damage the denominator than improve the numerator!  Finance sector deleveraging has, and will continue to constrain credit growth.  Of the measures announced in June by the ECB the TLTRO is most likely to have an impact on credit growth although greater supply of credit does not itself create demand.

All that said there are a number of worthy suggestions in Draghi’s speech.  Firstly, he believes “it would be helpful for the overall stance of policy if fiscal policy could play a greater role alongside monetary policy”.   He acknowledges the constraint that levels of government spending and taxation in the euro zone are already amongst the highest in the world.   A while be also believes it would be self-defeating to break the rules of the Stability and Growth Pact, he states the existing flexibility within the rules could be used to better address the weak recovery and to make room for the cost of needed structural reform.  Couldn’t agree more.

Secondly Draghi states “No amount of fiscal or monetary accommodation, however, can compensate for the necessary structural reforms in the Euro area.”  Couldn’t agree more (2). He believes that the reform agenda should span labour markets, product markets and actions to improve the business environment. 

He goes on to highlight two areas of labour market reform he sees as priorities - policies that allow workers to redeploy quickly to new jobs and raise the skill intensity of the workforce.  You guessed it: Couldn’t agree more (3).

This was an important speech, well beyond its implications for monetary policy.  I still think economic conditions will eventually see the ECB implement a more fulsome program of asset purchases.  But, again, all that will do is buy time for the more important growth enhancing work to be done.  Without that the Euro zone appears destined for a very long period of very low growth.  Call it secular stagnation if you like.