The Chinese economy regained some momentum during the second half of 2014, but mixed leading indicator / monetary signals suggest that growth will remain moderate.
The six-month increase in industrial output peaked at 5.7% (not annualised) in December 2013, falling to a low of 3.0% in August 2014 before recovering to 4.4% in December*. Output rose by a strong 1.3% in December alone, partly reflecting catch-up after a below-par gain in November (when production was depressed by factory shutdowns to curb pollution in Beijing during an APEC meeting).
The economic slowdown and recovery were foreshadowed by falls followed by rises in real (i.e. inflation-adjusted) money supply M2 growth and a composite longer leading indicator – see first chart**. The leading indicator increased further in December but real money growth has fallen back since September. Monetary trends typically provide an earlier signal so this combination suggests that economic momentum will continue to strengthen in early 2015 before fading again towards mid-year.
Slightly better economic news reduces the urgency of further policy easing. Near term at least, the authorities may prefer targeted measures to cuts in reserve ratios or official interest rates, which would risk reigniting excessive stock market speculation. Record turnover in the Shanghai A share market in December was 2.4 times the previous monthly high in July 2009 – second chart.
*These figures are based on a seasonally-adjusted level series compiled by the World Bank.
**The components of the leading indicator are the NBS purchasing managers’ index, steel production, cargo handled at major seaports, the industrial sales / output ratio, residential floorspace sold and bank loans.
Yesterday’s shock decision by the Swiss National Bank (SNB) to abandon the 1.20 floor for the euro / franc rate was strange in several respects.
Fixed currency arrangements usually break down because the effort to maintain them has produced excessively restrictive or loose domestic monetary conditions. The Swiss monetary and economic backdrop, however, is benign. GDP grew by a respectable 1.9% in the year to the third quarter while domestic prices – as measured by the GDP deflator – were stable. Unemployment of 3.1% is close to its 10-year average. Monetary growth is subdued, with M3 and M1 up by 3.6% and 3.1% respectively in the year to November – see chart.
The SNB suggested yesterday that the franc’s recent weakness against the US dollar warranted allowing it to appreciate against the euro. Yet the effective exchange rate, as of Wednesday’s close, was slightly higher than a year ago. There was no depreciation to correct.
The SNB was concerned that the franc would be dragged lower by a further fall in the euro, suggesting that it expects the ECB to surprise markets with a large-scale QE package next week. Even if this scenario plays out, however, there is no obvious advantage in the SNB acting before the event.
It has been claimed that the SNB was constrained from conducting foreign exchange intervention on the necessary scale because of the size of its balance sheet, with assets currently equal to 84% of annual GDP. Any such constraint must be political rather than economic – the monetary authority of a strong currency can accumulate reserves without limit.
If Japan followed Switzerland’s accounting practice of including official currency reserves on the central bank’s balance sheet, the Bank of Japan’s assets would be 94% of GDP currently, with a further significant increase planned.
Nor was the SNB out of interest rate ammunition, as yesterday's 0.5 percentage point cut in target rates shows.
The SNB was wrong to abandon its traditional emphasis on domestic monetary stability in favour of an exchange rate target in 2011, but yesterday’s volte face was ill-timed, lacks a convincing rationale and will inflict significant short-term economic pain.
UK annual consumer price inflation fell from 1.0% in November to 0.5% in December (0.55% before rounding). The decline was entirely due to a faster rate of decline of energy prices – down an annual 5.8% in December versus 0.2% in November*. “Core” inflation – excluding energy, food, alcohol and tobacco – recovered to 1.3% last month from 1.2% in November.
This core measure understates domestic inflationary pressure because it incorporates a drag on prices of tradeable goods and services (excluding energy and food) from sterling strength in 2013 and the first half of 2014. Non-energy industrial goods prices fell by an annual 0.3% in December; without sterling’s appreciation, they might have risen by about 1%**. This suggests a negative impact on core inflation of about 0.5 percentage points***.
Sterling’s effective rate has stabilised since mid-2014 and manufactured import prices have started to recover, rising an annual 1.0% in November versus a 4% fall in March. This may be reflected in firmer consumer prices of non-energy industrial goods in early 2015.
Bank of England research confirms a large drag effect from the exchange rate on current inflation. In a speech in October, MPC member Kristin Forbes reported simulations on the Bank’s COMPASS model suggesting that 2013/14 sterling strength would cut CPI inflation by about 1 percentage point by end-2014, up from about 0.4 percentage points in the first quarter
An alternative approach to gauging domestic inflationary pressure is to focus on services inflation, which is less affected by changes in commodity prices and the exchange rate, although not impervious****. Annual services inflation was 2.3% in December versus 2.4% a year earlier.
The official consumer prices index (CPI) excludes owner-occupiers’ housing costs. The alternative CPIH measure includes such costs using a “rental equivalence” approach, but the Office for National Statistics has stated that its estimates of rental inflation are biased downwards. It recently started to publish an alternative series for owner-occupiers’ costs based on the “net acquisitions” approach; this rose by an annual 4.1% in the third quarter – see previous post for more details. An alternative measure of services inflation incorporating this series using the relevant CPIH weight stood at 3.0% in the third quarter.
The suggestion that domestically-generated inflation is above 2% is supported by recent national accounts prices data, with the caveat that these are subject to revision. The deflator for “gross value added at basic prices” – a measure of prices of domestically-produced goods and services sold both in the UK and overseas – rose by an annual 2.4% in the third quarter.
*The energy weight is 8.0%, implying an impact of -0.45 percentage points.
**Annual inflation averaged 1.0% over 2010-14.
***Based on a 39.7% weight of non-energy industrial goods in the core basket.
***Examples of effects include foods costs on catering services, energy costs on transport services and the exchange rate on foreign holidays.
The global longer leading indicator* tracked here continued to firm in November, suggesting that a recent recovery in industrial output growth will be sustained through spring 2015.
The indicator is giving a more hopeful message than a year ago. The first chart shows the position at end-2013. Global growth – as measured by the six-month change in output in 14 large economies – had reached its highest level since October 2011, contributing to widespread optimism about 2014 prospects. The leading indicator, however, had fallen significantly from a peak in July 2013, suggesting an economic slowdown during the first half of 2014.
The second chart shows the current position. Global growth moved lower from January 2014, bottoming in August before recovering through November. The leading indicator, meanwhile, revived in early 2014 and has continued to rise recently.
Economic uncertainty has been heightened by a 44% plunge in the oil price, as measured by spot Brent, between June and December 2014. Some commentators argue that this weakness is a negative signal for the global economy. The table documents changes in global growth six and 12 months after previous large oil price declines. The six-month results are mixed but growth was higher in all five cases after 12 months.
|OIL PRICE DECLINES OF 30%+ OVER SIX MONTHS|
|CHANGE IN SIX-MONTH INDUSTRIAL OUTPUT CHANGE*|
|AFTER SIX MONTHS||AFTER 12 MONTHS|
|*G7 + E7 FROM 1998, G7 BEFORE|
A lower oil price transfers income from exporters to importers. Assuming that importers’ marginal propensity to consume / invest is higher, this transfer should boost growth. In the short run, however, exporters may cut spending more quickly than importers raise it, resulting in a neutral or negative impact. The table suggests that positive effects dominate after 12 months.
*The indicator combines a large number of forward-looking data series and leads cycle turning points by about six months. The November reading incorporates December data where available in the calculation of trends in the components.
The annual change in Eurozone consumer prices dropped to -0.2% in December from 0.3% in November, with the negative reading reflecting falls in energy and unprocessed food prices. Excluding these categories, prices rose by an annual 0.7%, unchanged from November. A narrower “core” inflation measure excluding energy, food, alcohol and tobacco firmed to 0.8%, above its level at end-2013 – see first chart.
Core inflation is unacceptably weak but the ECB has already reacted, cutting official rates in June and September, offering cheap long-term funding for bank lending and embarking on QE focused on private-sector securities. Monetary policy affects the economy with a six to 12 month lag and inflation after about two years. Monetary trends provide early evidence about its effectiveness. Six-month growth in Eurozone narrow money M1 rose from 4.1% annualised in May, before the ECB’s first rate cut, to 9.9% in November. Broad money M3 growth increased from 1.0% to 5.3% over the same period. The euro’s effective exchange rate, meanwhile, has fallen by 4% since mid-2014.
The economic definition of “deflation” is a pervasive and persistent decline in prices associated with sustained money and credit weakness. The Eurozone isn’t in deflation currently and the risk of it entering such a scenario has diminished.
German releases today were encouraging, with the level of unemployment falling to a 23-year low in December, unfilled vacancies at a new record and retail sales volume rising by a solid 1.0% in November (although monthly changes are notoriously volatile). The German economy is effectively at full employment: the unemployment rate stood at 5.0% in November versus 5.8% in the US and 6.0% in the UK in the three months to October – second chart.