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.
The global leading indicators followed here were little changed in September and remain consistent with a recovery in industrial output growth.
The indicators are based on the OECD’s country leading indicators but are designed to provide earlier warning of growth turning points. The short leading indicator typically leads turning points in six-month global industrial output growth by 2-3 months and the longer leading indicator by 4-5 months.
The longer leading indicator reached a trough in December 2013, with the shorter version following in February 2014. This suggested that global industrial output growth would recover from mid-2014. Weakness, in fact, extended through August, partly reflecting the impact of Japan’s April sales tax rise – see previous post. Output growth rebounded to its June level in September, however – see first chart.
The short leading indicator was stable in September at its highest level since November 2013, while the longer version edged down. Based on the average lead times, this suggests that global industrial output growth will recover further during the fourth quarter but will level off around year-end. With the recent growth trough occurring later than expected, however, the next peak could be correspondingly delayed.
Global real narrow money trends are consistent with a moderation in output growth from early 2015 – see previous post.
Within the global aggregate, the Eurozone longer leading indicator continued to recover in September, supporting the positive message from recent stronger real narrow money expansion – second chart.
A September post suggested that UK average earnings growth was about to rise significantly, based on the historical relationship with job openings (vacancies). The annual increase in whole-economy average weekly regular earnings was then 0.8%, referring to July, but has since firmed to 1.8% in September. Earnings rose at an annualised rate of 3.0% between the second and third quarters – see first chart.
The acceleration has been driven by the private sector. Private regular earnings grew by 2.3% in the 12 months to September and by 3.1% annualised between the second and third quarters.
The quarterly rise in hourly earnings was larger than in weekly earnings, because average weekly hours worked fell from 32.2 to 32.1 between the latest two quarters.
Monetary policy doves will argue that the earnings pick-up reflects stronger labour productivity: GDP is currently estimated to have risen by 0.7% (not annualised) last quarter, while aggregate hours worked in the economy fell by 0.1%. Productivity, however, was stagnant between the third quarter of 2013 and the second quarter of 2014 – the trend, therefore, is still weak.
The rise in earnings growth is viewed here as the consequence of an increasingly tight labour market. The job openings rate (i.e. vacancies as a percentage of filled and unfilled jobs) rose further in the three months to October and is now close to its 2008 peak – second chart*. Earnings growth has started to pick up nine quarters after the openings rate embarked on a sustained increase in the second quarter of 2012. This is consistent with the average lag at major earnings growth lows in the 1970s and 1980s – see the earlier post for details.
Stronger earnings growth validates the concerns of the two MPC hawks, Ian McCafferty and Martin Weale, but they have no support from the rest of the Committee, judging from the resolutely dovish tone of today’s Inflation Report. The mean forecast of inflation in two years’ time based on unchanged policy was cut to 2.26% from 2.52% in August, signalling that the MPC consensus expects a much later and / or smaller rise in interest rates.
*Quarterly averages except for last data points, which are latest available.