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Markets nervous
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Increases on stock markets continued in arly May, along with rise in raw materials, in environment of confidence due to excellent prospects set out by International Monetary Fund.
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The month of May will likely be remembered for the financial upsets which broke out at the end of the second week. Up to then, everything went along the bubbling normalcy seen in recent months. That is to say, the stock markets on the rise, raw materials at all-time high levels and yields on long-term bonds settling into an upward course. Furthermore, the International Monetary Fund had certified the strength of the current expansionist stage of the world economy and it even seemed that something of an international consensus had been reached on suitably rearranging the exchange rate risks connected to the dollar.
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But suddenly markets slip into unexpected stage of drops which may be seen as correction of past excesses.
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But as of the third week of May everything changed. The stock markets suffered a notable punishment with some markets seeing their cumulative gains for the year being lost in just a few days. Emerging country markets were the ones to suffer the biggest drops. Russia, India, Indonesia and Brazil dipped sharply after having marked up all-time highs in the second week of the month. Something similar happened with raw materials which recently have become subject to speculation. Both crude oil and industrial metals and precious metals suffered a notable drop since May 12.
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Why did such major corrections take place? There is no single reason. We should probably seek the cause in the correction of past excesses. The most widely-held impression is that investors were understating the risks and almost becoming reckless. Up to now, the rise in share quotations had paid little attention to the gradual tightening of monetary policies, the high prices reached for oil and other raw materials, the worsening of world discrepancies in balance of payments and tenuous signs of inflation. The risk premiums on bonds of emerging countries had reached all-time lows. The perception of risk was practically non-existent.
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In May nothing substantially changed on the international economic scene. However, the more that companies record exceptional profits and their financial situation shows as excellent, the immediate future now cannot be better. We are going to see somewhat less growth, somewhat more inflation and higher interest rates. We therefore must be more selective. US inflation and uncertainty about the coming action of the Fed has set off a state of nerves which has spread rapidly to the markets provoking moves which are probably excessive.
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In fact, figures for economic situation still good, both in United States…
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In fact, the figures for the economic situation continue to be splendid. For example, growth in the United States. In the first quarter, the gross domestic product (GDP) was up more than 5% at annualized rate compared with the previous quarter, thus creating fears about an early slowdown. Indeed, a slowdown is noted in the real estate field (less demand, little increase in prices) but all at the rate of a «soft landing». In any case, job creation is still going full-steam-ahead and the unemployment rate stands at low levels.
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…and in Japan and Euro Area where recovery now established.
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In Japan, the figures are also favourable. The growth of neighbouring China, with a figure of 10%, has a lot to do with this. But the important factor is that domestic demand has decided to come out from under. Japan’s economy seems on the way to becoming normal following many years in the mire. In the first quarter of 2006 growth was 3.0% at year-to-year rate, not as sharp an increase as in the fourth quarter (rise of 4.0%) but one that allowed the labour market to put the unemployment rate at 4.1%, the lowest in the past eight years.
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There is also good news from the Euro Area. Growth of 2% seems assured in 2006. Keeping in mind that this is close to potential growth estimated for the 12 member states with the euro as currency, the current situation must be seen as positive. No problems with inflation are foreseen although no one should let down their guard because there could still arise some so-called «second round» effects arising from the rise in oil prices (wage increases, increases in government charges, etc.).
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We should also pay attention to German recovery. While at this moment economic situation indicators in Germany are very favourable, the impact of the tax package adopted by the coalition government could distort the current good course being followed. The latest warning comes from the mediocre results in the other two large Euro Area economies, France and Italy. The most recent indicators point in a good direction but what is troubling is the strange French political situation which comes on top of elections expected in 2007, all of which does not contribute to bringing about reform policies. In Italy, the political situation has cleared following the recent elections but some aspects of the policy of the new cabinet are still to be firmed up.
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It is a pity that the small Euro Area economies cannot set themselves up as engines of growth, given that they present prospects that are much clearer. The European Commission foresees major growth for Ireland (nearly 5% in 2006) and for Luxembourg (4.4%), while in Greece and Finland it will be around 3.5%.
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Spain’s economy: high growth has its price
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Doubts persist about future course of German, French and Italian economies, the three «big boys» of Euro Area…
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Growth forecasts for Spain in 2006 are also favourable and run within a narrow margin between 3.1% and 3.3%. Because of its size and strength, Spain’s economy now indeed constitutes a pillar of recovery in the Euro Area. The forecast would be excellent if it were not for the persistence or worsening of foreign and inflationary imbalances.
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…while Spain’s economy runs full-steam-ahead at 3.5% with no substantial changes over last year’s trends.
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As the Bank of Spain had indicated, GDP growth in the first quarter stood at 3.5%, according to the early estimates from the National Institute of Statistics. This rate was the same as that recorded in the second half of last year. Stability is therefore the characteristic note of the figures for national accounting in recent quarters. And not only in terms of growth. What also is a constant is the contribution of national demand to growth (5 percentage points) and that of foreign demand, which draws off 1.5 points from the growth rate of the gross domestic product.
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Household consumption gradually moderating while general government enjoying excellent financial situation.
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By components at a broken down level, what stands out is the strength still being maintained by private consumption which is growing by 4.0%. The biggest drive is coming from services while the part corresponding to durable goods seems to be slackening, as can be seen in the most recent indicators for car sales and retail buying. The slightly downward profile of consumer spending by households is in contrast to the rise in consumption by general government. In this case, the substantial increase in salaries of public servants is not affecting the excellent situation of the public sector accounts. The increase in central government tax collections has made it possible to present a notable increase in the Treasury surplus in the first quarter.
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Investment is also going through a splendid moment. Spending on equipment and machinery grew somewhat less than in previous quarters but it is still at rates of more than 8% in real terms. On the other hand, investment in construction has again gone against forecasts that were betting on a slowdown. In the first quarter of the year, residential building increased its year-to-year growth rate to 7.4% in real terms. In fact, demand for housing continues very strong if we are to judge by the rate at which mortgage loans are being granted. By March, loans by banks and savings banks for home purchase continued to grow at the same rate as at the end of 2005, that is to say, an above 24%. And this despite the fact that interest rates have risen. The Bank of Spain calculates that while last summer credit institutions were lending at an interest rate of 3.2%, in March they raised the rate to 3.7% and the trend is to further increases.
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Far from moderating,home purchase maintains full strength, helped by interest rates still below inflation rate as well as job creation.
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Interest rates with mortgage security still stand below the inflation rate. And employment does not stop rising which also represents a stimulus and support for housing demand. The rate of job creation for some months has been stable at 3.2%, which has meant the creation of 575,000 new full-time jobs in the past year. According to the Labour Force Survey, the number of persons with jobs in the first quarter amounted to 19.4 million, nearly 5% more than one year earlier. Immigrants accounted for a good part of the new jobs created.
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Counteracting good results in growth and employment comes surprisingly rapid worsening of foreign deficit and persistence of higher inflation than among neighbouring countries.
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The excellent results in terms of growth and employment have their negative side. Or, rather, two negative sides, namely foreign deficit and inflation. In the first quarter of 2006, exports of goods showed very favourable results seeing that they rose by 12.7% at constant prices. However, the poor situation in exports of services (affected by the drop in inflows from tourism) and the renewed drive in imports resulted in a rapid worsening of the foreign balance for goods and services. If we add to this the negative trend in other operations with abroad, the result is a current account deficit equivalent to 10.6%. This is an all-time high and may be affected by seasonal factors but it is troubling if we take into account that in 2005 there was a deficit of only 7.4% of the GDP.
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With regard to inflation, in recent months the GDP deflator has stood close to 4.5%, a very high level indeed. The level of unit labour costs, which are a significant indicator of competitiveness in terms of abroad, growth stood at 2.3% in the first quarter, a rate in contrast with the lower growth for the Euro Area as a whole at 1.2%. Inflation and the foreign deficit, in fact, are two imbalances that partly arise from the sharp drive in domestic demand but not for that reason are they any less troubling because of their potentially adverse effect on the present favourable economic situation.
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Chronology
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CHRONOLOGY
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2005
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April
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20 |
Dow
Jones index for New
York stock exchange marks
up annual low (10,012.36) with 7.1% drop compared with end of 2004. |
| May |
2 |
Cypriot
pound,
Latvian lat and Maltese
lira join Exchange Rate
Mechanism. |
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3 |
Federal
Reserve raises reference
rate by quarter point to 3%. |
| June
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30 |
Federal
Reserve raises reference
rate by quarter point to 3.25%. |
| August
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9 |
Federal
Reserve raises reference
rate by quarter point to 3.5%. |
| September
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17 |
Increase
in special taxes
on alcohol and tobacco to finance health (BOE 17-9-05). |
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20 |
Federal
Reserve raises reference
rate a quarter-point to 3.75%. |
| October |
4 |
IBEX
35 index for Spanish
stock exchange marks up
annual high (10,919.2) with cumulative gains of 20.2%. |
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13 |
Government
approves National Reform
Programme for Spain. |
| November |
1 |
Federal
Reserve raises reference
rate to 4%. |
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28
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Slovak
crown joins Exchange Rate
Mechanism. |
| December
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1 |
European
Central Bank raises official
interest rate to 2.25%. |
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13 |
Federal
Reserve raises reference
rate to 4.25%. |
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17 |
European
Council approves 2007-2013
Budget. |
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18 |
Hong
Kong Summit of World
Trade Organization agrees
to removal of all aids to agricultural exports of developed countries in 2013.
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2006
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January
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20 |
Government
presents bills for reform of personal
income tax and corporate
tax. |
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31
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Federal
Reserve raises reference
rate to 4.50%. |
| March |
2 |
European
Central Bank raises official
interest rate to 2.50%. |
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28 |
Federal
Reserve raises reference
interest rates to 4.75%. |
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31 |
Government
approves economic policy
package including budgetary
measures and others on mortgage market, energy sector and rail transport. |
| May
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2 |
One-month
forward price of Brent quality oil
goes up to all-time high of 74.28 dollars a barrel. |
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4 |
Agreement
between government, business organizations and trade unions on labour
reform aimed at reducing
extent of temporary work. |
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9 |
IBEX
35 index for Spanish
stock exchange marks up
annual high (12,083.3) with cumulative gains of 12.6% over end of December 2005. |
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10 |
Federal
Reserve raises reference
rate to 5%. Dow Jones index for New
York stock exchange records
annual high (11,642.7), a rise of 8.6% compared with end of 2005.
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Agenda
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AGENDA
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June
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5 |
Industrial
production index (April). |
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8 |
Meeting
of Governing Board of European Central Bank. |
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13 |
Consumer
price index (May). |
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14 |
Quarterly
survey of labour costs (1st Quarter). |
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15 |
HCPI
for European Union (May). |
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26 |
Producer
price index (May). |
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29 |
Early
HCPI indicator (June). Meeting of Open Market Committee of Federal Reserve.
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July
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5 |
Industrial
production index (May). |
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6 |
Meeting
of Governing Board of European Central Bank. |
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14 |
Consumer
Price Index (June). |
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17 |
Harmonized
Consumer Price Index for EU (June). |
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25 |
Producer
Price Index (June). |
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28 |
Labour
Force Survey (2nd Quarter). Early HCPI indicator (May).
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