Growth and austerity - Economics weekly

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Growth and austerity - Economics weekly

Austerity is back in the spotlight. The European Commission gave three countries the green light to slow their deficit reduction.

Economic Analysis

03 June 2013

But in the US the economy is recovering faster despite much more aggressive cuts. The Americans it seems are the only ones managing to pull off the sought-after expansionary fiscal contraction.

Happy days are here again?

The US housing market is motoring. Prices were up 11% y/y in March, according to Case-Shiller, although the pace of growth is uneven: San Francisco's 22% increase compared with only 5% in Cleveland. Mortgage applications for house purchase are 10% higher than a year ago. And the stock of foreclosed properties is down 24% y/y.

Should we start worrying about another bubble? Some investors who had been buying distressed properties are exiting the market. But prices still look low. Adjusted for inflation, they are back to where they were in 2000. No need to worry just yet.

Other data confirmed the increasingly rosy outlook. US consumer confidence increased sharply in May to its highest level in five years. The banking sector reported a 16% y/y rise in net income in Q1 driven by lower losses on past loans and higher volumes of business, despite tighter margins. Small firms want more credit, they are getting it and their loan default rates continue to fall.

In the last month, the dollar has appreciated by 3% and ten year bond yields have risen by 50 basis points. Fed governors are openly musing about slowing the pace of quantitative easing. This is still slower than a typical US rate of recovery but it is starting to head that way.

Even slower US GDP growth had a silver lining

Headline growth was revised down to 2.4% annualised in Q1, but even this wasn’t bad news. Government spending contracted by almost 5% in, wiping a full percentage point off overall growth, which emphasised the strength of the private sector recovery. This comes on the back of a Q4 that saw government spending falling at 7% annualised, the scale of which has been exceeded by only Iceland and Ireland.

UK house prices up 0.4% in May

The UK returned to growth in Q1 and optimism about the economy appears to be feeding through to the housing market with house prices up 0.4% in May, according to Nationwide. It’s not just prices that are on the up either.

The number of property transactions in the first four months of the year was 5% higher than the monthly average in 2012. The average house price is now £167,912 - a 1.1% increase on the average in May 2012 - and London continues to outperform the rest of the UK with prices in the capital now at a record high.

With interest rates set to remain at rock bottom for the foreseeable future and inflation falling back in April, this general sentiment of economic optimism may provide further boosts to the housing sector in the coming months. That doesn’t mean the risks have disappeared however as wage growth continues to look abysmal and real pay is now back at 2003 levels.

UK business borrowing continues to fall

Net borrowing by non-financial corporations fell by £3bn in April, the sharpest drop in the year so far, and was 4% lower than in the same month a year ago. Loans to small and medium-sized enterprises dropped by £700m, the biggest fall since December. It’s taking longer than expected for the Bank of England’s Funding for Lending Scheme to feed through to the UK corporate sector.

Panic over…?

The Eurozone has been in recession for a year and an half and the weakness that started in the periphery has spread to the core. What’s more, public finances are still shaky. The European Commission’s annual assessment of every country’s economy showed that only 6 of the EU's 27 states have avoided the label of having an "excessive deficit" in recent years. But despite the recession and the still prevalent deficits the sovereign debt crisis feels a lot less acute than it once was.

A good measure of that pressure is the interest rates markets are demanding on government debt. Whilst rates on German and UK debt are very close to where they were a year ago, rates in the periphery have fallen spectacularly. Spanish and Italian yields are now close to 4%, whilst Irish and Portuguese rates have halved. With the promise of a backstop buyer of bonds in the ECB, markets are more comfortable with the reality of recession than the threat of euro exit.

...but the pain endures

Eurozone unemployment rose to 12.2% in April, or 19.4m people, up from 12.1% a month earlier. Youth unemployment also grew, with almost one in four people under 25 years of age out of work. Markets may be calmer now than a year ago, but for many people their personal situation is much worse.



This material is published by The Royal Bank of Scotland plc (“RBS”), for information purposes only and should not be regarded as providing any specific advice. Recipients should make their own independent evaluation of this information and no action should be taken, solely relying on it. This material should not be reproduced or disclosed without our consent. It is not intended for distribution in any jurisdiction in which this would be prohibited.

Whilst this information is believed to be reliable, it has not been independently verified by RBS and RBS makes no representation or warranty (express or implied) of any kind, as regards the accuracy or completeness of this information, nor does it accept any responsibility or liability for any loss or damage arising in any way from any use made of or reliance placed on, this information. Unless otherwise stated, any views, forecasts, or estimates are solely those of the RBS Group’s Group Economics Department, as of this date and are subject to change without notice.

The classification of this document is PUBLIC. © Copyright 2013 The Royal Bank of Scotland plc. All rights reserved.


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