Getting down in Davos - Economics Weekly


Getting down in Davos - Economics Weekly

It was never going to be a particularly jolly affair, but the mood at this year’s annual meeting of the World Economic Forum was much gloomier than previous years. The IMF announced a substantial reduction to its 2012 global economic forecast.

30 January 2012

No surprises about where it laid the blame - Europe. And the Brussels summit this week will address how to improve growth in the Eurozone. Confidence needs to be restored to achieve this, but for this to happen a realistic plan to end the crisis has to be in place. With continued wrangling about how best to achieve this, and Greece still a big worry, the delegates won’t be feeling happy on their way home from Switzerland. At least there was some better news from the US where GDP growth picked up in the final quarter. While there are still risks ahead, this could be light at the end of a very long tunnel.

The UK economy whimpered out of 2011

The first estimates of GDP growth in Q4 2011 suggest the UK economy shrank by 0.2%. At 0.9%, growth in 2011 was less than half of the 2.1% in 2010. It is also lower than expected, which has heightened fears that the UK is either heading towards, or already in, another recession. The last time the UK economy had a double-dip recession was in 1975. First estimates are frequently revised, so things might not be so bad, but the underlying figure exposed two concerns. The first is that services sector growth, previously the main driver of the UK economy, was flat. The second is a 1.2%q/q fall in industrial production, disappointing hopes of a sustained recovery pinned on manufacturers.

Steady as she goes from the Bank of England

The Monetary Policy Committee voted unanimously to leave both interest rates and its £275bn Asset Purchase Programme unchanged in January. Stronger US economic data and the positive impact of the ECB’s liquidity operations were bright spots in the minutes. And the Committee was also happy about slowing inflation in recent months, although it warns that there is still uncertainty about price growth in 2012. “Some members” were in favour of more QE once the current round of asset purchases comes to an end in February. And the weak UK economic growth data will strengthen the case for this.

UK public sector debt reaches £1 trillion – but it’s not all bad news

Despite the big number, there are signs that public sector finances are coming under control. Spending cuts along with higher receipts last year, especially from VAT, mean that public sector net borrowing was £11.3bn lower in this fiscal year than 2010/11. It now looks like the Government will undershoot the 2011/12 borrowing targets outlined in November. But the bad news is that austerity is a marathon not a sprint, so there are five more years of it ahead. Public sector net debt breached the symbolic £1tn mark in December, but this shouldn’t be a shock. When put in context it equates to 64.2% of UK GDP. This is high by historical standards, but not out of line with other major economies (US: 72.6%, Germany: 57.2%, France: 81%).

Eurozone private sector activity shows unexpected growth in January

The composite Purchasing Managers Index (PMI) for services and manufacturing moved back into expansion territory (a reading above 50) in January. The PMI rose to 50.4 from 48.3 in December, driven by a strong upturn in Germany and modest growth in France. Despite this the outlook is still weak. Inflows of new business are still falling and firms are cutting employment to reduce costs.

US economic growth was robust in Q4 2011

After a slow start to the year 0.7%q/q growth in Q4 leaves overall growth in 2011 at a healthy 1.7%. It’s not bad, but there were mixed messages beneath the headline. Increases in inventories gave the biggest push to growth whilst consumption was also strong. But the higher spending on durable goods wasn't matched by higher incomes. Elsewhere business investment was mediocre, net trade was static and the public sector shrank.

US to hold interest rates until mid 2014, but unemployment will still be sticky

On top of announcing that it will hold rates until 2014, the Fed set a specific inflation target of 2%.This is an historic move and has been a goal of Chairman Bernanke as he seeks to increase transparency at the US central bank. The Fed doesn’t see inflation as a problem though. Its central projection is below this target up to the end of 2014. But unemployment is trickier. The Fed does not see it falling from its current 8.5% to a more ‘normal’ rate within the forecast range of 5.2-6% before the end of 2014. The overall assessment of the economy was pretty downbeat, despite better data of late. While more quantitative easing was not mentioned, it is still an option. Especially with inflation below target and unemployment still high over the forecast period.

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