Daily Economic Briefing: April 26, 2010

Daily Economic Briefing: April 26, 2010

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• Cyclical recovery dynamics continue to strengthen in an impressive way, putting upside risk to our forecast that global GDP will grow 3.5% this year (4q/4q), or about a point above trend. These dynamics are based on the interaction between policy, financial markets, confidence, consumption and business spending. The powerful surge in global capital goods shipments highlighted in this week’s GDW cover essay should be viewed in this regard.

• Compared with our forecast, the potential for positive growth surprises appears focused in the US, Asia and Latin America. Compared with market perceptions, however, the biggest surprise may be shaping up in the Euro area. The latest round of business surveys points to a sharp acceleration in the Euro area economy, with current-quarter GDP growth likely to top 3% (q/q, saar). A simultaneous lift in consumption, capex and net trade is driving the pickup in Euro area growth, notwithstanding the headwinds from fiscal retrenchment.

• This week’s reports may trigger a further upward revision to our 1H growth forecast for Japan (currently 2.8% annualized), which already was raised by 1% pt early this month. In addition to momentum in the April business surveys, we will be looking for signs that domestic demand growth remained solid in March (consumption reports, capital goods shipments). We already learned last Thursday that net trade is tracking above forecast. It also will be important to see the March CPI report. There are very tentative indications that the rate of core deflation (defined to exclude all food and energy prices) stabilized in 1Q10. Indeed, the BoJ appears to believe that the worst is over for deflation now that the output gap has begun to close. Our Japan team believes the BoJ will say as much in this Friday’s Outlook report, arguing that deflation will end in sometime in FY2011.

• This week’s 1Q10 inflation report in Australia also bears watching. The RBA meets next week, and the decision appears to be a close call. Confirmation that core inflation remains at the upper end of the central bank’s 2%-3% band would make us more confident that the Bank will deliver a sixth 25bp hike to 4.50%.

• There are eight central bank meetings on the calendar this week. With the slide in core inflation in focus and the level of activity still depressed, the Fed is expected to maintain its low for long language. In the wake of disappointing data releases, the RBNZ is likely to soft-pedal expectations that it will hike rates in June. Today the Bank of Israel, one of the few banks that is normalizing rates, left policy on hold. Hungary’s central bank, one of the handful that is still easing, delivered an expected 25bp cut. Brazil’s COPOM will kick off its rate cycle with either a 50bp or a 75bp hike on Wednesday.

Our economic forecast calls for record lows in core consumer price inflation in the developed economies this year. In response to this undershoot of their forecasts and objectives, central banks in the G-3 are expected to leave rates on hold until sometime next year. By contrast, we think core inflation already has bottomed across most of the EM.

Underpinning these core inflation forecasts is our belief that the recession generated a massive amount of resource slack in the DM economies, and that this slack is exerting significant downward pressure on DM wage and price inflation via the well-known Phillips curve relationship. By contrast, we think resource utilization is about average in the EM.

We measure global, DM, and EM resource utilization (RU) by combining available data on unemployment and manufacturing capacity utilization across a wide range of countries. Although our database is fairly comprehensive, it is limited to a subset of the countries encompassed in our global economic forecast, because some countries, including China, do not publish the needed data (see the tables on page 3). Our measure of RU is expressed in terms of standard deviations from the long-term average. We report it this way to create a common denominator, since some countries report capu as an index rather than a percentage.

From a high of 1.2 std deviations above average in late 2007, global resource utilization plunged to a low of 2.0 std deviations below average in late 2009. The recent low far exceeds any in the history of our series. There is a wide gap in RU between the DM and the EM. In 4Q09, RU was 29 std dev below average in the DM, whereas it was 0.7 std dev above average in the EM. This gap exists because the EM economies entered the downturn in a more overheated condition, and because unemployment rose much less over the past two years in the EM compared with the DM.

With above-trend growth in prospect for 2010 and 2011, we look for RU to rise across the board in coming quarters, beginning with 1Q10. The recovery in RU is expected to be somewhat stronger in the DM than in the EM, reflecting some convergence in growth rates among the two blocks.

For the DM, the low but rising rate of RU raises an interesting question about the path of core inflation. If there are no lags between RU and inflation and if inflation expectations are perfectly anchored (both questionable assumptions), then core inflation probably should bottom, versus the further decline built into our forecast. Under the same assumptions, the steady rise in RU to above par points to a rise in core inflation in the EM economies.

ENDS

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