Research Dept. News
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Monthly Report, num 359 - July-August 2012
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Executive summary
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The euro crisis is jeopardizing the global recovery
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Global growth loses steam.
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International economic activity is showing some weakness in these central months of the year. Reports on the manufacturing sector highlight that growth in the United States, China and other emerging countries is more fragile than expected, while the euro area is still under the effects of the recession. One sign of this cooling off in expectations is the fall in the price of a barrel of crude to 90 dollars, almost 30% lower than the annual peak reached in March. However, the main concern is still the euro crisis, both with regard to growth prospects and also sovereign debt tensions, the impact of fiscal adjustment and the capacity of governments and European institutions to arrive at effective solutions. Within this context, investors have reacted with differing degrees of sensitivity, in general opting for caution.
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The US recovery weakens and the Fed forces more relaxation in interest rates.
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With regard to the US economy, this is on its way to a weaker scenario than the consensus had expected at the end of April, after the publication of the gross domestic product (GDP) flash estimate for the first quarter. The main reason for this cooling off lies in the loss of dynamism in the labour market's recovery. A weaker labour market inevitably leads to a standstill in household income, which ends up affecting private spending on consumer goods, the driving force behind activity. However, our forecast for the GDP flash estimate for the whole of 2012 remains close to 2% as the improvement in the housing market and particularly the drop in oil prices could offset a large part of these weaknesses. The risk, nevertheless, is of worse figures as the euro area crisis and the gradual slowdown in some emerging countries could continue for some time yet.
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China, like other emerging countries, is applying stimulus measures to contain the slowdown in activity.
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The Federal Reserve (Fed), the central bank of the United States, recognizes that the economy has become weaker and has lowered its growth forecasts. As a consequence, the Fed has decided to keep interest rates within the range of 0%-0.25% and, moreover, to extend the period of application for the so-called «Operation Twist» up to the end of 2012. With this programme, which was originally planned to end in June, the authority aims to continue extending the average duration of its debt portfolio and reduce long-term interest rates even further, if necessary. By buying long-term US Treasury bonds and selling those with a maturity of less than three years, the Fed aims to make the financing conditions more flexible for the private sector and dispel any deflationary threat to the economy.
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Indicators point to a slowdown in activity for China. However, May's figures were better than had been expected by analysts and are in line with a soft landing, in accordance with our growth forecast of around 8% in 2012. Moreover, the inflation figures, below the government's target of 4%, have allowed it to continue with its expansionary policies. Along the same lines is the reduction in the official interest rate of 25 basis points, down to 6.31%, at the beginning of June, and the cut of 50 basis points in the cash reserve ratio mid-May. For the remainder of the year, we predict further reductions in the cash reserve ratio of between 100 and 150 basis points, as well as a further cut in interest rates at the beginning of the third quarter.
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The euro area crisis becomes the main problem for the world economy.
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With regard to Brazil, the growth figures for the first quarter were a disappointment, with GDP growing by a mere 0.2% compared with the previous quarter, which represents a meagre advance of 0.8% in year-on-year terms. The economy is immersed in very low growth without there being any sign of the upswing it so desires, at least for the time being. Given this evidence, the Brazilian authorities quickly announced further measures to boost their economy, including greater credit facilities, barriers to imports and a new line of credit available to the states. However, the Mexican economy has remained vigorous thanks to renewed strength in domestic expenditure in an environment of price moderation.
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But the main problem worrying the world economy is still the situation of the euro area. Investor uncertainty seems to be unjustified. The good news from the Greek elections has hardly made any impact on this lack of confidence. Prior to the elections, most people thought that Greece would leave the euro area. But the outcome has been a tripartite government between the conservatives of the New Democracy, the socialists of Pasok and the Democratic Left party, all of them pro-Europe, it having been announced that the European Union might allow Greece more time to reduce its fiscal deficit.
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Neither the acceptable outcome of the Greek elections nor the announcement of a financial bail-out for Spain dispels the uncertainty.
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Neither did the announcement of financial aid for Spain of up to 100 billion euros to recapitalize its banking system serve to calm the markets. The punishment of sovereign debt of countries on the periphery of Europe, and specifically Spain, has not been contained. Another factor leading to this penalization are the credit downgrades applied by the main ratings agencies to the Kingdom of Spain as well as a large part of its national financial institutions. Yield on Spanish 10-year bonds therefore broke through the barrier of 7% and stayed there for various sessions, and their spread with the German bund once again exceeded 500 basis points, the highest since the country joined the euro. Under these conditions it is obvious that non-official external financing, both for the public and private sector, has fallen to minimal levels.
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The summit held by the European Council at end of June is a new opportunity to adopt viable solutions to put a stop to the current regression. This month, Cyprus has announced its request for emergency funding from European bail-out funds, thereby joining Greece, Ireland, Portugal and Spain. With the perception that the markets could cause solvency problems in Spain and with Italy in the firing line, ultimately what is at stake is the very survival of the single currency, a key pillar to the current construction of Europe.
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Will the European Council manage to achieve effective solutions?
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The heads of government and state that are meeting in Brussels will propose steps towards closer financial, fiscal and budgetary integration, including some kind of supranational bank supervision, a common mechanism to guarantee deposits and resolve bank crises and a communitarization of sovereign debt. But these reforms require a lengthy schedule and very solid political commitment, making them medium or long-term solutions. However, market uncertainty demands fast, decisive solutions to stop the situation from deteriorating to such an extent that it becomes irreversible, aimed at hiving off sovereign risk from banks or at the financing capacity of bail-out funds. At the time of writing this edition, the initial news points towards significant progress in this direction.
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The Spanish economy falls further into recession.
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Another measure being considered by European leaders is the launch of policies aimed at growth, with sizeable investment plans. The fact is that, whereas the euro area economy had zero growth during the first quarter of the year, it may have shrunk considerably in the second quarter, according to leading economic indicators. This constitutes another source of pressure on the bailed-out economies, which have less room to expand in external markets.
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In the case of the Spanish economy, its recessionary profile is similar, insofar as it is estimated that activity has fallen more in the second quarter than in the first (-0.3% quarter-on-quarter). On the supply side, in addition to the slump in the construction and real estate sector, manufacturing is still contracting, while the public sector is cutting spending, beset by demands to reduce its deficit.
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Widespread economic weakness and constant deterioration in the labour market.
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Most indicators, both for supply and demand, have remained negative and are worse than in previous months. This is the case of the consumer confidence index and the construction confidence index, as in May both fell by 5 and 6 points respectively compared with the previous month. In addition to consumer confidence falling to the level of spring 2009 is the drop in sales of retail and consumer goods, down in April by 9.5% year-on-year. With regard to the foreign sector, the latest figures for April reveal that exports dropped by 0.8%, although May's external tourism indicators were positive. Economic weakness is a characteristic shared with most of Europe, so exports to our main trading partner fell by 4.6%.
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The effects of the recession can be clearly seen in the labour market. Although the number of people registered as employed and unemployed in May showed some improvement, this was thanks to the seasonal nature of the period as, once the figures had been adjusted, the result was a substantial deterioration in the variables. The adjustment in the labour market is being carried out mainly via the number of employees although wages are also responding to the weaker economic activity, albeit to a lesser extent. The quarterly labour cost survey for the first quarter of 2012 shows greater wage containment with wage costs per worker rising by 1.2% year-on-year, a rate slightly slower than the one recorded the previous quarter. Similarly, wage moderation helped labour costs per worker to slow up considerably, with a year-on-year growth rate of 1.1%.
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Non-compliance of the target public deficit demands an ambitious political response.
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In turn, the decline in domestic demand is leading to a larger drop in tax revenue than expected, jeopardizing the capacity to achieve the public deficit target accepted for this year, namely 5.3% of GDP. In spite of the reforms undertaken to date and the effort being made by public administrations to tackle budget deviations, it is true that, as stated by the preliminary report by the International Monetary Fund, additional measures must be urgently taken. These must be capable to tackling the challenges of a double-dip recession, unacceptably high unemployment, a public debt that is rocketing up to unsustainable levels and a financial sector that needs to recapitalize some of its elements. The next few weeks will be decisive in this respect, both in terms of possible new packages of economic policy and also the response and effectiveness of European institutions.
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28 June 2012
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Chronology
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Agenda
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