GDP price statistics in today’s revised third-quarter report confirm that domestically-generated inflation has risen since early 2014, in line with an earlier pick-up in monetary growth. The annual increase in the deflator for “gross value added at basic prices” – a measure of prices of domestically-produced goods and services – was 2.3% last quarter, up from 1.3% in the first quarter and the highest since the third quarter of 2012.
GDP price statistics, admittedly, are often revised significantly. The 2.3% third-quarter figure, however, is consistent with analysis in a previous post suggesting that consumer price inflation would now be 2.0-2.5% rather than 1.3% in the absence of falls in global commodity prices and sterling appreciation.
In an October speech, MPC member Kristin Forbes suggested using two variants of the GVA / GDP deflator to assess domestically-generated inflation: the GVA deflator excluding government and the GDP deflator excluding exports. The former measures private sector domestic inflation while the latter focuses on domestic production sold in the UK. The annual rises in the two measures in the third quarter were 2.2% and 4.1% respectively – see chart.
Meanwhile, annual inflation of services producer prices – another measure cited by Dr Forbes – rose to 1.5% in the third quarter from 0.8% in the first quarter and 1.3% in the second.
The monetarist rule of thumb is that inflation follows monetary growth with a variable lag averaging about two years. Annual expansion of the broad non-financial M4 money measure peaked in May 2013, slowing only modestly since, suggesting that underlying inflation will continue to firm into mid-2015.
ECB President Mario Draghi last week expressed pessimism about near-term Eurozone economic prospects, citing a weak November “flash” purchasing managers’ survey. The survey, he said, “suggests a stronger recovery is unlikely in the coming months, with new orders falling for the first time since July 2013”.
President Draghi’s comment refers to the Markit Economics “composite” PMI survey covering services and manufacturing. This survey, in fact, is hugely overrated as a forecasting tool. Historically, even the new orders component has been, at best, a coincident indicator of the cycle.
The last Eurozone recession, for example, ended in the first quarter of 2013, with GDP growing by 0.3% in the second quarter. The PMI composite new orders index, however, remained below the “break-even” 50 level until mid-2013.
This year, the composite PMI has been misleadingly strong until recently. Based on the July survey, Markit Economics estimated that Eurozone GDP had grown by 0.4% in the second quarter while German GDP was on course for a 0.7-0.8% third-quarter rise. The outturns were 0.1% and 0.1% respectively. The PMI has now reset lower in line with actual economic results.
The November fall in the composite new orders measure reflected weakness in the services component. Manufacturing new orders are judged here to be a better coincident indicator of the cycle and have been stable since September. The longer leading indicator suggests a coming rise – see chart. Today’s German Ifo survey for November, showing the first increase in manufacturing expectations for seven months, is an encouraging sign.
UK experience demonstrates the perils of using the services PMI as a forecasting guide. The survey suggested that the economy was heading into a “triple-dip” recession in early 2013: the new business component fell below 50 in November and December 2012, prompting Markit Economics to opine that “activity may continue to fall in the new year”. GDP rose by 0.5% in the first quarter of 2013.
President Draghi, of course, will be aware of these issues. He may or may not believe that “a stronger recovery is unlikely in the coming months” but it suits his purpose to draw attention to PMI weakness to make the case for further monetary policy easing. An ECB leadership bent on further stimulus when monetary trends are improving and the economic cycle is turning up suggests a benign backdrop for equities.
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.