The not-so-magnificent seven - Economics weekly


The not-so-magnificent seven - Economics weekly

The G7 will not remember Q4 2012 fondly. Last week we had GDP releases for Japan, Germany, Italy and France. All four – like the US and the UK before them – showed a fall in economic activity.

Economic Analysis

18 February 2013

Inflation to stay above target, according to the Bank of England’s new forecast

Back in the pre-crisis days, economists used a simple rule of thumb when trying to predict the path of UK interest rates: if inflation was forecast to be above target in two years' time, then rates were likely to go up. Now, things are more complicated. The Monetary Policy Committee thinks inflation will still be above the 2% target in Q1 2015, but has given clear guidance that it will overlook this overshoot.

This is because it expects inflation to eventually fall back below target, and doesn't think it would be worth trying to speed up this decline at a time when the economy is so weak. We expect the policy rate to remain on hold until 2016.

Price stability, sort of

UK inflation was 2.7% y/y in January on the consumer price index. This is the fourth consecutive month that prices have grown at this rate – a record in the 20-year old series. Food and drink added upward pressure to inflation, but this was countered by the January sales. As noted already, the MPC has conceded that above-target inflation will be with us for a few more years.

Conspiracy theorists suspect that this could be an attempt to inflate away the UK’s sovereign debt burden. But our analysis shows it would take a 1970s style burst of inflation to have a meaningful impact on debt.  Despite David Bowie releasing a new album, it does not feel like a return to this era is on the cards. Read our analysis: can the UK inflate away its debt problems?

UK consumers remain cautious

High inflation and weak wage growth are a strong headwind for consumers, and this will have contributed to a disappointing start to the year for retailers. The value of retail sales fell by 0.4% m/m in January, and was flat in y/y terms, though the picture looks somewhat brighter if we exclude petrol stations. Small retailers were under greatest pressure, especially in the food sector, as the snow in January encouraged consumers to shop online with larger retailers. This highlights the importance of having a strong internet presence.

In contrast, US retail sales hold up in January

Consumers continued to open their wallets, with retail sales rising 0.1% m/m in January (+4.4% y/y). Department stores saw the largest monthly increase in sales, while the online phenomenon continued its march in the US as well, as non-store retailers saw a 15% y/y jump in sales. Total sales have increased for three months in a row, undoubtedly buoyed by an improving labour market. But the January increase was much smaller than in December and November, which suggests the recent payroll tax hike may have reduced consumers’ willingness to splash the cash.

Eurozone recession deepened in Q4 2012

The Eurozone economy shrank by 0.6% q/q in the final quarter of last year. This was the third straight quarter of contraction and the worst performance in almost four years. Weakness was broad-based across the members of the monetary block, and the so-called “core” economies are no longer immune. The German economy shrank 0.6% q/q in the three months to December, while French GDP fell 0.3%. Peripheral economies struggled even more with Italy reporting a fall in economic activity of 0.9% q/q and Spain showing a contraction of 0.7%.

Japan also dragged further into the mire

Japan's economy shrank in Q4, by 0.1%. This was the third straight contraction for the world's third largest economy. The problem in 2012 was with trade: net exports were a drag on growth for most of the year, as the move away from nuclear power led to increased energy imports. GDP growth for 2012 as a whole came in at a fairly respectable 1.9%, but this is flattered by the effect of the earthquake and tsunami on activity levels in 2011.

Confused about the yen? You will be!

Confusion reigned in foreign exchange markets last week. Markets interpreted a statement on Tuesday by the G7 Ministers and Governors, which included a pledge not to target exchange rates, as evidence that they were relaxed about Japan’s efforts to weaken the yen. As the Japanese currency fell further, a G7 official had to intervene, and clarify that the statement had actually been intended to signal “concern about excess moves in the yen”. The yen then resumed its decline on Friday, when it was suggested Japan would not be named and shamed at the G20 meeting in Moscow.

That’s six out of six. The declines may have been small, but we haven’t had a ‘full house’ since the dark days of 2009. Let’s hope Canada bucks the trend when its GDP numbers are released next week.

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