Weak Chinese October monetary data signalled that additional policy stimulus would be required to sustain economic growth at its recent pace – see previous post. The People’s Bank announced a modest easing step today, lowering the benchmark one-year bank lending and deposit rates by 40 and 25 basis points respectively. The suggestion of a fall in banks’ interest margin is reinforced by an accompanying rise in the permitted ceiling for deposit rates to 1.2 times the benchmark rate from 1.1 previously.
The question is whether this action will prove “too little, too late”. Despite receiving negative headlines, yesterday’s Markit “flash” manufacturing purchasing managers’ survey for November offers some reassurance. The key forward-looking new orders index remained stable at a level consistent with a further near-term recovery in six-month industrial output growth – see chart.
A bumper gain in Japanese exports in October suggests that world trade growth is continuing to firm, consistent with the expectation here of faster global industrial output expansion into end-2014.
The Netherlands CPB research institute compiles monthly data on global trade volume. The six-month change peaked at 3.4% (not annualised) in November 2013, falling to -0.6% in May 2014 before recovering to 1.3% in August, the latest available month – see first chart. (The May low is consistent with the forecast here in early 2014 that global economic momentum would reach a trough in the late spring. Six-month industrial output growth, however, bottomed later than expected, in August – see previous post.)
Japanese real exports track* the CPB global trade measure with a “beta” of roughly two. They rose by 3.8% last month after a 1.8% gain in September. Six-month growth climbed to 4.9%, the fastest since August 2013 – first chart.
The suggested global trade pick-up is supported by evidence from other countries enjoying less of a currency tailwind. Chinese and Korean exports, and Taiwanese export orders, have surprised positively in October. Six-month growth of German real export orders rose to 4.7% in September.
Stronger exports should contribute to the six-month change in Japanese industrial output moving back to positive territory by end-2014 from -4.1% in September, implying a significant boost to global production expansion – second chart.
*The relationship was temporarily disrupted in 2011 by the Tohoku earthquake / tsunami.
Current Eurozone triple-dip recession worries are reminiscent of a similar scare in the UK in early 2013*. Monetary trends and other evidence suggest that they are equally groundless.
- Both scares were triggered partly by weak but distorted economic data. UK GDP fell by 0.3% in the fourth quarter of 2012 but this followed a large third-quarter boost from the Olympics. Current Eurozone worries were fanned by a shock 4.0% drop in German industrial output in August but the number was distorted by holiday timing effects; production returned to its May / June level in September.
- The IMF slashed its UK growth forecast in April 2013 while stating that the government was “playing with fire” by continuing to pursue fiscal consolidation. It now claims that there is a 40% chance of a Eurozone recession by mid-2015. The IMF’s forecasting record is poor and it is often an excellent contrarian indicator.
- UK business surveys and labour market indicators were stable in late 2012 / early 2013, signalling that companies did not expect an economic downturn and were not beginning to retrench. The EU Commission’s Eurozone “economic sentiment indicator” – a composite survey measure – rose in October and is slightly above its long-run average. Eurozone unemployment is stable and lower than a year ago. German job openings reached a record last month.
- UK fiscal consolidation was slowing in 2013. According to the Office for Budget Responsibility, cyclically-adjusted net borrowing fell by 3.0% of GDP between 2009-10 and 2011-12 but by only 0.9% of GDP between 2011-12 and 2013-14. According to the IMF, the Eurozone structural budget deficit – a similar concept – was cut by 2.5% of GDP between 2011 and 2013 but will decline by only 0.3% of GDP between 2013 and 2015.
- Most importantly, the UK recession scare was completely at odds with monetary trends: six-month growth of real narrow money M1 rose strongly during 2012 and was running at about 4% (not annualised) by early 2013. The build-up of cash in current accounts signalled that spending intentions were firming. Recent ECB easing has contributed to an increase in Eurozone six-month real M1 growth, to 3.2% in September – see previous post. By contrast, real M1 contracted before the 2008-09 and 2011-12 Eurozone recessions.
UK GDP growth rose to 2.4% annualised during the first half of 2013 and 3.1% over the subsequent five quarters. A similar Eurozone pick-up is not in prospect: monetary trends are less strong than in the UK in early 2013, while potential economic expansion is lower. GDP growth, nevertheless, could recover from 0.5% annualised during the second and third quarters of 2014 to 1-2% in 2015, assuming no monetary relapse or external shocks. A further upgrade may be warranted if real money expansion continues to firm.
*The UK was thought to have suffered a minor double-dip recession in late 2011 / early 2012, based on official data at the time. This was disputed in posts here and the GDP decline has since been revised away.
Posts here from summer 2013 suggested that the trend in UK consumer price inflation would shift from down to up in spring 2014 in lagged response to faster monetary growth and associated economic strength. This forecast has proved wrong because of unexpected significant declines in global energy and food commodity prices and sterling strength. “Deep core” inflation, however, has probably firmed since early 2014.
Annual CPI inflation was 1.3% in October, up from 1.2% in September but down from 1.7% in the first quarter of 2014. A commonly-used measure of “core” inflation strips out energy, food, alcohol and tobacco. This has fallen by much less – from 1.6% in the first quarter to 1.5% in October.
This core measure, moreover, incorporates the drag on inflation from a 14.5% rise in the effective exchange rate between March 2013 and July 2014. According to simulations on the Bank of England’s COMPASS model reported by MPC member Kristin Forbes in a speech in October, this rise was expected to cut CPI inflation by about 1 percentage point by end-2014, up from about 0.4 percentage points in the first quarter. This estimate relates to the headline rate rather than core inflation. Nevertheless, it is reasonable to suggest that the core measure would have firmed from about 2% in early 2014 towards 2.5% now in the absence of sterling’s rise.
An alternative approach to gauging underlying pressure is to focus on services inflation, which is less affected by the exchange rate and commodity price changes, although not completely insensitive. CPI services inflation was 2.5% in October versus 2.4% in the first quarter. Services producer price inflation, meanwhile, rose from 0.8% in the first quarter to 1.6% in the second*.
Recent stronger average earnings growth is consistent with a rising core trend. Doves argue that higher wage growth will be matched by faster productivity expansion, resulting in little change in unit wage costs. Historically, however, prices have exhibited a stronger correlation with earnings than unit wages. This may be because rising earnings growth is usually accompanied by a widening of margins, which offsets the inflation benefit of improved productivity.
Recent further commodity price falls and the lagged impact of prior exchange rate strength will continue to obscure the trend in core inflation until well into 2015. The MPC should be directing attention to core risks and keeping the door open to an early Bank rate rise, thereby acting symmetrically with its approach during the 2010-12 inflation overshoot.
*Third quarter released on 26 November.
Chinese October activity news last week was satisfactory but slower monetary expansion suggests that further policy easing is required to keep economic growth on track.
Industrial output rose by a seasonally-adjusted* 0.7% last month after a 1.7% in gain in September. Six-month growth reached its highest since January. The recent pick-up was foreshadowed by an increase in official and Markit manufacturing purchasing managers’ new orders indices between March and July. These have since fallen back but remain consistent with a further near-term growth recovery – see first chart.
Recent measures to stabilise the housing market, meanwhile, may be bearing fruit, with the annual fall in floorspace sold slowing sharply to 3.4% in October from 12.1% in September. Prices lag sales but their rate of decline may be approaching a bottom – second chart.
October money and credit figures, by contrast, were downbeat. Six-month growth of real M2 fell to its lowest since November 2013 while the narrower M1 measure contracted. M2 outperforms M1 as a leading indicator of the economy in China and is not yet flashing red. The growth decline, however, suggests that the current economic pick-up will give way to another slowdown from early 2015 without additional policy stimulus.
*Based on World Bank seasonal adjustments.