Chief Economist's Weekly Brief 5-10-09
Economies across the world are seeing signs of the end of recession and a nascent recovery. Output is rising, confidence is up and asset prices appear to be recovering. But a return to growth is not straight forward. Unemployment is still rising in many places and the spectre of deflation remains apparent in the EU, US and Japan.UK Households are behaving much as policy makers would have wished – saving more but not reducing debt levels too rapidly. The savings ratio, the proportion of income remaining after consumption, rose to 5.6% in Q2, up from 3.9% in Q1. It may rise further if past experience is a guide: the ratio peaked at 12% after the last recession..
Households are also re-investing in their homes. For most of this decade the opposite was true. Housing equity withdrawal averaged 5% of income each quarter, but in Q2 households re-invested 3% of income. Since 2008 a total of £29bn has been invested back into the housing stock.
Confidence around the housing market is helping prices stabilise. According to the Nationwide, the first index out each month, prices rose by 0.9% m/m in September. This was the fifth consecutive monthly increase, leaving house prices essentially flat on a year earlier. Is the rise sustainable? It would be very unusual for prices to continue to climb as the savings ratio rises and more income is devoted to reducing debt.
The UK manufacturing sector looks to be stabilising. According to the September PMI survey, manufacturing recorded a reading of 49.5, fractionally below the 50 mark which separates expansion from contraction. Although down marginally from 49.7 last month, it appears that the worst is over for manufacturing after steep losses. Order books are improving and export demand in particular is picking up, in part thanks to a weaker pound, but also because of the recovery in global demand.
US labour market conditions continue to deteriorate. The unemployment rate rose to 9.8% in September from 9.7% in August, following a large fall in total employment. The non-farm payroll report showed that total payroll employment declined by 263K in September. This was much worse than expected by a consensus of economists, and it was the first time in three months that the pace of job-cutting increased rather than decreased.
This led to some jitteriness in financial markets with the S&P500 down 3.5% on the week. Markets were also concerned by weaker than expected data from the manufacturing sector. The Institute of Supply Managers (ISM) report, showed a decline in business confidence in the manufacturing sector to 52.6 from 52.9 in September. While still in expansionary territory (and an improvement on readings at the turn of the year), analysts had been expecting a stronger performance.
Also in the US, the housing market rebound continued at pace. Home prices rose for a third consecutive month in July, by 1.2% m/m, the biggest gain since October 2005. But such rapid growth is likely unsustainable. A separate report on consumer confidence by the Conference Board found that the share of Americans expecting to purchase a home within six months fell to 2.3% in September from 3% in August. With the tax credit due to expire in November, it is too early to say that the housing market has stabilised.
Indicators of consumer and business confidence in the euro area improved in September. According to the European Commission, signs of the developing recovery are filtering through to expectations from households and industry, which rose to a 12 month high.
Yet falling prices pose a threat to the recovery. Consumer price inflation fell to -0.3% in September, bringing the period of falling or flat prices to five months. The European Central Bank expects inflation to average 0.4% this year, which would require a pretty sharp rebound in Q4. This may prove difficult as inflation expectations have turned negative, meaning consumers expect prices to fall further in the months ahead.
Unemployment in the euro area in August rose to 9.6% from 9.5% the month before. But the headline rate distorts the regional dynamics. Since the beginning of the deterioration in labour markets in March last year, 58% of the increase in unemployment has come from Spain, and Ireland has seen the numbers out of work double.
Inflation in Japan fell at the fastest rate seen since the survey began in 1971. Consumer prices were 2.2% lower than last year, increasing the risk that prolonged deflation could hamper the country's recovery. That said, the turnaround in industrial production since its trough in March continued, as output expanded 1.8% m/m, amid signs that the labour market deterioration could be levelling off.
And finally, the People’s Republic of China celebrated its 60th anniversary. The recovery is well underway in China, and growth looks set to return to 8% this year.