When doves cry - Economics Weekly

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When doves cry - Economics Weekly

Structural reform. That’s when governments reform markets – for example to boost competition – and invest in assets, from people to roads. Structural reform delivers faster growth but it offers jam tomorrow. To be sure, the Eurozone needs reform in spades but it needs substantial support today to escape weak growth and high unemployment.

Economic Analysis

07 December 2015


Let down.

It was like waking up on Christmas morning to discover Santa has not visited. European Central Bank President Mario Draghi disappointed markets last week with a dose of monetary policy easing that failed to live up to expectations. The Bank's deposit rate was cut by 10 basis points to -0.3% and the current programme of quantitative easing (QE) was extended from September 2016 to March 2017. Markets wanted a rise in the €60bn per month pace of QE. President Draghi again implored governments to undertake structural reforms to help boost growth. But the Eurozone economy needs all the policy support it can get. A more aggressive form of QE would have been warranted.



The Eurozone is enjoying a period of stable, if modest, growth, according to the Purchasing Managers’ Index (PMI). It rose to 54.2 in November from 53.9. Both manufacturing and service firms reported a sight increase in activity, as did all participating countries. Only France, perhaps understandably, did not register faster in growth. Ireland remains the pick of the bunch, with Spain second. And similar to most of the world, inflationary pressures are nowhere to be seen.


A saviour.

The UK economy should end the year in decent shape, thanks to the service sector. The PMI for services rose to 55.9 in November, from 54.9. This suggests overall GDP growth of around 0.5%-0.6% in Q4 and 2.4% for 2015. Meanwhile, the manufacturing index, despite falling, implies the sector is making a modest recovery. This cannot be said for construction. The index fell over three points and there's concern about a lack of new work.



The Bank of England thinks the UK financial system is now operating in more normal times, compared with anything we’ve seen since the crisis. But not all is rosy. The Financial Stability Report highlighted the UK property market, especially the growth of buy-to-let, as a continuing area of focus. The Financial Policy Committee (FPC) recognises that some of this expansion is a natural reaction to a growing share of renters. But it thinks these investors could be quicker to sell in a downturn, injecting more volatility into the market. Given the recent changes to stamp duty and interest deductibility the FPC is happy to wait and see what happens, but will be watching closely for signs of growth getting out of hand.



Borrowing via loans and credit cards grew 8.2%y/y in October, significantly faster than borrowing at 2.4%y/y. This bears a remarkable resemblance to the period of credit growth that followed the housing bust of the early '90s and the exit from the Exchange Rate Mechanism. This time the regulatory and supervisory framework is quite different and, as well as buy-to-let, the FPC will be keeping an eagle eye for any signs of over-heating.



China’s economy continues to show signs of struggle. The manufacturing PMI edged up by 0.3 points to 48.3, suggesting demand remains weak. The readings for Taiwan and South Korea, both of which have close economic ties to China, are also struggling, with new export orders well below the 50-mark. And the slowdown in manufacturing and real estate continues to infect China’s services sector with the services PMI pointing to muted growth.


Getting by.

And it’s not just China. The US manufacturing ISM (PMI-equivalent) fell to its lowest level since 2009, continuing the trend of falling readings seen over the past year. Weakness in global demand, the recent strengthening of the dollar and the pullback in investment in the energy sector are all likely to blame. At least the US services sector is in better shape. However, the reading of 55.9 is a six-month low. Perhaps some of the weakness in manufacturing is filtering through to the services side. The growth backdrop to the Fed raising rates is far from shooting the lights out.


More of the same.

But raise rates is precisely what the Fed is set to do next week. Chair Yellen last week voiced concerns that further delaying the decision to raise rates might mean having to raise them too sharply at a later date, risking recession and financial instability. The rate rise case was strengthened by the creation of another 211,000 jobs in November. Unemployment remained at 5.0%, close to the level the Fed thinks represents an economy in balance. Hourly wages rose 2.3% but there are no signs of a threat to inflation from the job market.



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