Latin America in a Global Context - Economic Briefing February 2005

Global Economy Loosing Steam as Japan and Europe Slumber

The global economy experienced a year of rock-solid growth in 2004. This year, however, the pace will moderate significantly as the stimulating effects of accommodative fiscal and monetary policies that boosted the economic expansion last year are ending. Nevertheless, all major economic regions will expand this year, with the upturn being most pronounced in emerging Asia, particularly China. In Japan, the outlook continues to deteriorate, as the growth spurt observed last year seems to have remained short-lived. Rather than seizing the momentum from the external sector to rekindle the domestic economy, Japan will fall back to lacklustre growth, which has characterised the country for most of the past decade. The U. S. economy will grow strongly but remains burdened with sizeable current account and public sector deficits, which have sent the US$ tumbling to new lows against the Euro. Meanwhile, the Federal Reserve continues to tighten its policy to rein in inflationary pressures resulting from the ongoing recovery. Notably lagging the U.S. economy in the business cycle, monetary tightening is not on the agenda in the Euro Area, which continues to battle with sluggish domestic demand, which has been exacerbated by the effects of the weaker US$. Latin America is emerging from the fastest economic expansion in a decade and even though the pace will not be upheld in this year, the region will continue to grow favourably, as the export-led recovery has already spilled over to increased domestic demand.

U.S. economy recovers from soft patch as consumption rebounds in third quarter

According to advance estimates released by the Bureau of Economic Analysis (BEA) on 28 January, GDP increased at an annual rate of 3.1% in the fourth quarter over the same quarter the year before, which was down from the 4.0% growth for the third quarter.  The actual reading was well below expectations, which had seen the economy advancing by 3.5%.  The deceleration in economic growth in the fourth quarter compared to the third primarily reflected a slowdown in durable goods consumption and slower growth in exports, which was exacerbated by an acceleration in imports.  The inventories build-up accelerated in the fourth quarter, partly offsetting the weakening factors.  Thus, GDP increased 4.4% last year, following on an increase of 3.0% in 2003.  The acceleration observed in 2004 was broad-based and seized consumption and investment alike.  Durable goods consumption expanded at a slower 6.9% rate (2003: 7.4%) but faster non-durable and services consumption more than compensated for the slump with a 3.8% expansion compared to 3.3% in 2003.  Growth of gross fixed investment doubled to a 10.0% expansion over the previous year and exports accelerated even more from 1.9% in 2003 to 8.1% in 2004, which was partly compensated for by an acceleration in imports.  Imports once more defied the downside effect from the weaker US$.

Consumer confidence dips in January

More recent economic data provide a mixed picture.  Consumer confidence fell slightly in January due to less favourable expectations about future economic conditions.  The pessimism was partly compensated for by a more upbeat assessment of current economic conditions.  The index of consumer sentiment of the University of Michigan reached 95.5 in the January 2005 survey, down from 97.1 in December.  However, the decline in January only partly reverses the very strong 4.3 percentage point gain observed in the December 2004 survey.  In January, the majority of consumers still expect good times financially in the economy as a whole, despite the anticipated moderation in economic growth.  In fact, consumers actually judged their current financial situation more favourably than at any other time during the past four years.  That said, developments in the labour market remain a key issue of concern.  On 4 February, the government reported that U.S. employers added only 146,000 jobs in January, compared to a 200,000 job gain expected by the market.  The slow pace of job creation was due to the weakness in key sectors, in particular manufacturing, which lost 25,000 jobs amid more extensive seasonal shutdowns than usual for the month particularly in motor vehicles and parts.  However, a drop in job-seekers pushed the unemployment rate from the previous 5.4% to 5.2%, its lowest level in more than three years.  As a result, employment returned to where it was before the 2001 recession began and the job losses of President Bush's first term were erased. 

Monetary authorities continue tightening

On 2 February, the Federal Reserve decided to raise the target for the benchmark federal funds rate by 25 basis points to 2.5%.  The decision represented the sixth straight time that the Fed raised interest rates since June last year, when it initiated the tightening cycle.  According to the Fed, output appears to be growing at a moderate pace despite the rise in energy prices and labour market conditions continue to improve gradually.  Moreover, monetary authorities are likely to continue to tighten at a “measured” pace, suggesting similar increases of 25 basis points on the next meetings of the Federal Open Market Committee on 22 March and 3 May.  The tightening is not expected to hamper the robust growth of the U.S. economy.  In fact, Consensus Forecast participants maintained this year’s growth unchanged over last month at 3.5%. 

European Central Bank refrains from tightening as growth remains sluggish

Notably lagging the U.S. economy in the business cycle, the Euro Area has not yet embarked on monetary tightening.  At its last meeting on 13 January 2005, the Governing Council of the European Central bank (ECB) decided to leave its policy rate unchanged at 2.0%.  The Bank recognised that inflationary pressures persist in the short term but reckons that consumer prices will rise more moderately amid the lower oil price.  According to preliminary estimates, annual inflation reached 2.1% in January 2005, down from 2.4% in December 2004.  Moreover, the Central Bank currently sees no significant evidence that underlying domestic inflationary pressures are building up in the Euro Area.  In the third quarter, the economy expanded 0.3% on a quarter-on-quarter basis in seasonally adjusted terms.  While information on the fourth quarter is still incomplete, the latest economic and survey data suggest ongoing moderation in economic growth.  According to the European Commission’s indicator-based model for quarterly GDP growth for the Euro Area, the economy expanded between 0.2% and 0.6% in the fourth quarter of 2004 and will accelerate slightly to 0.3% to 0.7% in the first quarter of 2005.  This is an upward revision of 0.1 percentage points for the first quarter of 2005 compared to the previous forecast.  Consensus Forecast panellists are less optimistic and lowered their full-year forecast for 2005 GDP growth from the already paltry 1.8% expected last month to the current 1.7%.

Healthy prospects for Latin America despite export slowdown

In 2004, the Latin American economies expanded by 5.6%, according to the first preliminary government data and the latest Consensus estimates.  Last year, Latin America profited from strong global demand, which converted the external sector into the growth engine for the entire region.  However, last year’s export growth – in Chile, the fastest growing exporter, exports expanded by more than 50% - is unsustainable, in particular since the global economy will grow at a less vigorous pace than last year.  As a result, export growth is seen to shrivel from 22.4% in 2004 to just 3.5% this year.  In the meantime, the impulse from strong external sector growth has rekindled the domestic side of the economy, which will serve as the engine for growth this year.  Consequently, the deceleration will remain moderate.  According to this month’s projection, the region’s output will expand by 4.0% in 2005, up a 0.1 percentage point over last month’s forecast.

Outlook for Argentina improves as government is about to conclude debt crisis

This month’s upward revision to the economic growth outlook was broad-based, as it was prompted by better projections for five of the seven major economies in the region: Argentina, Brazil, Chile, Mexico and Venezuela with unchanged forecasts for Colombia and Peru.  The Consensus Forecast for Argentine GDP growth in 2005 added 0.2 percentage points over last month’s 4.9% projection to the current 5.1%.  The government could garner the necessary support for its debt swap plan, which would put an end to a three year period in default with constantly looming uncertainty about how to conclude the debt crisis.   Consensus Forecast panellists also lifted the GDP growth forecast for Brazil by a 0.1 percentage point over last month to the current 3.7%.  The upward revision follows on an upgrade of the same magnitude last month and was motivated by increased resilience in the domestic economy.  However, strong domestic demand is forcing the Central Bank to tighten monetary policy to rein in rising inflationary pressures, which will keep growth next year constrained at 3.5%.

Chilean outlook improves despite anticipated exports deceleration

In Chile, the prospects for 2005 improved despite the anticipated slowdown of the global economy, as the domestic side of the economy is picking up at a faster than expected pace.  As a result, the economy will hardly loose any momentum and GDP growth will only slow from 5.6% in 2004 to 5.4% this year.  With domestic demand accelerating, the Central Bank has to continue its tightening cycle in order to contain the resulting consumer price pressure. 

Mexican Central Bank continues to tighten policy and Venezuela benefits from buoyant oil economy

Panellists also lifted the outlook for Mexico, albeit by only 0.1 percentage point from 3.6% expected last month to the current 3.7%.  While the signs from the dominating industrial sector are promising, the Central Bank continues to tighten monetary policy to keep inflationary expectations in check.  Apparently, monetary authorities are being successful, since for the first time the economists surveyed in our panel lowered their year-end inflation outlook.  However, the current forecast still exceeds the Central Bank’s 3% target.  Finally, Consensus Forecast participants once again lifted their outlook for Venezuela.  The Venezuelan economy will expand 5.0% this year, according to this month’s projection, up 0.4 percentage points from last month’s estimate.  Venezuela should to benefit from the still strong oil price.  In addition, latest OPEC reports show that the country still has some leeway to increase oil output to mitigate an eventual decline in oil prices.