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High level of uncertainty
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Widespread pessimism at start of 2009…
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The year 2009 is beginning in an environment of widespread uncertainty which matured during 2008 when, in line with Murphy’s Law, everything that could get worse got worse. Is it just bad luck? There will be plenty of time to debate why the world economy has reached this point. The most relevant fact at this time is that the world has gone through much worse crises and that the lessons learned from those provide valuable resources to deal with the present situation. An addendum to Murphy’s Law states that, if things are left to themselves, the problems will go from bad to worse. This does not apply in this case, given that all governments affected have pulled out all their heavy monetary and budgetary artillery so that by the end of 2009 we may be able to see the current wave of pessimism as a broad exaggeration.
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For the moment, much to our sorrow, we stand in a season of bad news. The United States, the world’s leading economy, has been in recession since January 2008 although up to the first half of the year the main indicator, gross national product (GDP), had recorded advances. Nevertheless, since September the levels of economic activity have shown a sharp drop that means that forecasts for the fourth quarter are for a sharp drop in GDP, which will likely be repeated in the first quarter of 2009. What is going wrong? No doubt it is private consumption, which up to now has sustained precarious growth, heavily affected by a real estate sector that is going through a long deep recession.
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…because of flood of bad news in final stages of 2008.
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The withdrawal of the US consumer was not hard to foresee if we keep in mind that in the first 11 months of 2008 more than 1.9 million jobs were lost and the unemployment rate rose to 6.7% from the low of 4.6%. Furthermore, the recession has hit households with gross borrowing equivalent to close to 100% of GDP and with financial and real estate assets that have lost a good part of their value, in a context of tighter credit terms. The positive side was the collapse of oil prices which has returned some of the lost purchasing power but has been unable to re-establish confidence indicators and these are now running at levels close to all-time lows.
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Drop in oil prices returns some lost purchasing power but raises fear of deflation.
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The collapse in oil and other commodities had an unexpected negative effect. It raised fears of deflation. The US consumer price index (CPI) for November stood at 1.1% at annual rate after having reached levels of 5.6% last July. If oil prices do not jump in coming months, the CPI could go into negative rates before many months are over. In fact, we could not speak of deflation if the underlying segment of the index (that excluding volatile prices such as those of energy and foods) does not move onto negative ground. But the risk is there and recent experience with deflation (merely that of Japan) obliges us to pay full attention to this matter.
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The combination of recession with the risk of deflation has forced the Federal Reserve, the US central bank system, to strong rapid action. In fact, at the meeting of its monetary committee on December 16, it was decided to leave the reference rate within a band between 0% and 0.25%, a low never before set since the founding of the US central bank in 1913. Furthermore, the Fed took advantage of its press release to give out three important messages about the direction of its monetary policy. The first was that it would use all the methods available to it so that the US economy would return to a path of stable growth. The second point was that the present exceptional conditions would require maintenance of the present very low official interest rate for a long period of time. The third message was that over coming quarters the central bank would acquire large amounts of agency debt and bonds for which collateral was mortgage assets with the aim of supporting the mortgage market and the construction sector.
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Federal Reserve lowers reference rate to practically zero and plans to buy private sector bonds.
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The immediate effect of this policy has been a drop in interest rates for all terms. In the US interbank market where 3-month transactions were closing at 4.8% in October they are now doing so at 1.5%. Investors are ready to buy 10-year government bonds that are offering a yield of only 2.1% annual, far from the annual high of 4.3% reached in June. The cut in the Federal Reserve interest rate and the injection of massive amounts of liquidity have brought about a sharp depreciation of the dollar in the past month, namely 12% against the euro and 7.2% against the Japanese yen.
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Recession seems less severe in Euro Area but indicators keep getting worse.
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In the Euro Area, for the moment the recessive situation seems to be not as sharp although available figures for the fourth quarter indicate that, far from easing, the recession is getting worse. In July-September 2008, the GDP contracted for the second consecutive quarter, putting the economy in a situation of technical recession. With regard to domestic demand, the component most affected is gross fixed capital formation which, after growing by 2.6% year-on-year in the second quarter, scarcely reached a rise of 0.9% in July-September. In turn, private consumption, while showing nil growth in the third quarter, started out from moderate growth of 0.4% year-on-year. The foreign sector also slowed appreciably. In fact, the worse performance in exports and investment largely lies behind the move into recession, because of the less dynamic foreign and domestic situation and the added burden of an exchange rate showing effective appreciation.
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In view of this scenario, the European Central Bank (ECB) has also taken firm action. The reference rate went from 4.25% in July to 2.50% in December while, although to a lesser extent that the Fed, the ECB also injected massive amounts of liquidity, reflected in an increase in liabilities in its balance sheet. In any case, the ECB is maintaining a more orthodox position than its US equivalent seeing that, while the ECB is supporting the spending plans aimed at countering the severity of the economic slowdown, it reminds the member countries of the European Union of the need to maintain fiscal discipline over the medium and long term.
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ECB and other central banks cut reference rates.
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On the same day in December that the ECB cut its reference rate, the Bank of England lowered its rate by 100 basis points to 2%, the lowest level since 1951, because of the sharp worsening of the British economy. The Bank of Japan did somewhat the same thing maintaining its reference rate at 0.30% but on December 19 it decided to lower it to 0.10% and announced that it would broaden the buying of government bonds in order to inject liquidity into the Japanese economy.
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Emerging economies will not act as counterweight to recession in advanced economies.
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All these measures are an indication of the progressive worsening of the economic situation in the advanced economies. What is happening in the emerging economies? The slight prospects of a decoupling of those economies from the advanced economies, that might allow the emerging economies to drive the world economy, have almost completely vanished. The Chinese economy, the main contributor to world growth in 2008, is showing more and more signs of slowing down. Although the third-quarter GDP grew by 9.0% year-on-year latest supply and demand indicators show a much more depressed situation. In general, the brake on inflows of foreign direct investment and the dip in world trade will have their effect while the drop in commodity prices could substantially hurt the growth potential of producer countries.
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Spain’s economy also suffering recessive situation with direct impact on labour market.
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In Spain, following a GDP drop in the third quarter of 2008, the first quarter-on-quarter dip since the beginning of 1993, available indicators for the fourth quarter point to a sharpening of the contraction in economic activity. Household consumption continues to weaken especially in the case of consumer durables due to more restrictive financial terms, the increase in unemployment and especially because of fears about future prospects which comes out in a consumer confidence index at an all-time low level.
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Nor is investment showing a good moment due to the weakness of both domestic and foreign demand and the drop in corporate profits. On the supply side, the industrial sector is suffering a severe blow due to the drop in demand and an accumulation of problems of competitiveness. The epicentre of sector adjustment, however, is no doubt to be found in construction and especially in the real estate sector which showed a drop of 27.1% in housing sales in September compared with the same month the year before and a year-on-year decrease of 63.5% in approvals for new housing construction.
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The recessive situation in the economy shows up worst in the labour markets. Figures for those registered with Social Security in November show a sharpening in loss of jobs. On monthly average, the number registered as working stood at 18.72 million, a year-on-year decrease of 3.5% compared with a drop of 2.3% in October. In November, on monthly average, some 197,087 jobs were lost with a total of 671,772 in the past 12 months. As a result, unemployment showed a rise affecting nearly 3 million persons, according to figures for registered unemployed at employment offices in November, a rise of 43% year-on-year.
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Improvements in inflation and foreign imbalance while economic authorities launch new plan to stimulate economy.
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On the positive side of the balance sheet we find the decrease in inflation and the foreign imbalance. November saw a continuation of the slowdown in growth of the consumer price index, which went from 5.3% in July to 2.4% in November and it is expected that in coming months it will stand below 2%. With regard to the current account deficit, we should point out the tendency to improvement thanks to the fact that the trade balance and the incomes balance are increasing their imbalances at a substantially lower rate while the deficit in the transfers balance has dropped and the surplus in services has shown a moderate increase.
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Following the guidelines worked out by the European Union, on top of the measures already adopted to aid the financial sector, the government has announced a new plan for measures to stimulate the economy amounting to 8 billion euros for investment at the municipal level as well as 3 billion euros to carry out immediate measures to go into R&D, the motor vehicle industry, the environment, construction of public buildings and renovation of housing, minor transport infrastructures and measures linked to the delivery of social services.
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December 23, 2008
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Chronology
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CHRONOLOGY
2007
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December
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11 |
Federal
Reserve cuts reference rate
to 4.25%. |
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13 |
Central
banks in United States, Euro Area, United Kingdom, Switzerland and Canada announce
plan for coordinated
measures to relieve difficulties in monetary markets
brought about by financial upsets. |
2008
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January
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1 |
Further
enlargement of Euro
Area with entry of Cyprus
and Malta, making 15 member states. |
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22 |
Federal
Reserve reduces reference
rate to 3.50%. |
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30 |
Federal
Reserve reduces reference
rate to 3.00%. |
| March
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9 |
Spanish
Socialist Workers Party wins general
elections. |
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18 |
Federal
Reserve cuts reference rate
to 2.25%. |
| April
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18 |
Government
approves a Plan for
measures to stimulate the economy. |
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30 |
Federal
Reserve reduces reference
rate to 2.00%. |
| July |
3 |
European
Central Bank raises official
rate to 4.25%. |
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11 |
One-month
forward price of Brent
quality oil
goes up to all-time high of 146.6 dollars a barrel. |
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15 |
Euro
exchange rate hits 1.599
dollars, highest value since launching of European Single Currency at beginning
of 1999. |
| August
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14 |
Government
puts into effect its programme
of 24 economic measures
for 2008 and 2009. |
| September
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19 |
US
government presents bailout
plan for country’s banking system amounting
to 700 billion dollars. |
| October |
7 |
Spanish
government announces creation of fund
for purchase of financial assets
of financial institutions up to maximum of 50 billion euros and raises guarantee
on deposits and investments to 100,000 euros. |
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8 |
European
Central Bank, Federal
Reserve and Bank
of England cut official
interest rates by 50 basis points in joint move with other central banks. |
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12 |
Euro
Area countries agree on joint
action to strengthen financial
system up to end of 2009. |
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13 |
Government
authorizes granting of government
guarantees up to 100 billion
euros in 2008 on new financial transactions of financial institutions with possible
extension to 2009. |
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28 |
IBEX
35 index for Spanish
stock exchange marks up
lowest level (7,905.4) since 2004. |
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29 |
Federal
Reserve cuts reference rate
to 1.00%. |
| November |
6 |
European
Central Bank lowers official
interest rate to 3.25%. |
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15 |
Meeting
of G-20 in Washington to reform
international financial system. |
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20 |
Dow
Jones index for New
York stock exchange records
lowest level since 2003 (7,552.3). |
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28 |
Government
announces 8 billion-euro public
works plan for municipalities
and 3 billion-euro plan for investment in various sectors and economic spheres. |
| December |
4 |
European
Central Bank lowers official
interest rate to 2.50%. |
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5 |
Price
of Brent quality oil
drops to lowest level since January 2005 (41.86 dollars a barrel). |
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16 |
Federal
Reserve reduces reference
rate to band between 0%-0.25%.
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Agenda
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AGENDA
January
| 5 |
Early
HCPI (December). |
| 9 |
Industrial
production index (November). |
| 15 |
CPI
(December).
Governing Council of European Central Bank.
Harmonized CPI for EU (December). |
| 23 |
Labour
Force Survey (4th Quarter). |
| 26 |
Producer
prices (December). |
| 28 |
Fed
Open Market Committee. |
| 30 |
Balance
of payments (November). |
February
| 5 |
Industrial
production index (December).
Governing Council of European Central Bank. |
| 12 |
Early
GDP (4th Quarter). |
| 13 |
CPI (January).
EU GDP (4th Quarter). |
| 18 |
Quarterly
National Accounts (4th Quarter). |
| 25 |
Producer
prices (January). |
| 26 |
Balance
of payments (December).
EU Harmonized CPI (January). |
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