Latin America in a Global Context - Economic Briefing March 2006

Global Economy Poised for Robust Growth

The outlook for global economic growth remains good. While output growth is likely to slow slightly compared to last year, the global economy is likely to hold up against the adverse impact of the significantly higher oil price. The United States slowed towards the end of last year but is expected to rebound to a more robust pace in the first quarter. In Japan, in contrast, the outlook continues to improve as the economy accelerated notably towards the end of last year promising that the current recovery will take a firmer hold than in the past. Even the Euro Area that has represented a major drag to global economic growth during the past years is emerging from sluggish developments. Finally, prospects for Latin America remain solid, as the benign outlook of the global economy promises to support demand for key commodities.

U.S. economy grows at slowest pace in three years

The U.S. economy experienced a sudden and unexpected slump towards the end of last year.  Even though the government revised the advance growth estimate upwards from 1.1% to 1.6% according to preliminary estimates, the economic activity slowed substantially compared to the third quarter, when the economy expanded by 4.1%.  In fact, the fourth quarter marked the slowest pace registered since 2002 and thus ends one of the longest strings of sustained economic growth, as the economy grew in excess of 3% for ten consecutive quarters.  In spite of the lacklustre expansion at the end of last year, full-year growth came in at 3.5%.  Slower consumption growth, in particular durable consumer goods, accounted for the deceleration over the third quarter.  However, investment growth also slowed considerably.  Moreover, the deceleration reflected an acceleration in imports and a downturn in federal government spending, which were partly offset by a strong upturn in inventories.

Consumer confidence weakens

Surprisingly, consumer confidence has weakened amid lower stock prices and a rebound in gasoline prices.  In February, the University of Michigan’s consumer sentiment index declined to 86.7 from 91.2 in January.  The reading continues a series of erratic shifts that had been kick-started in September last year, when sharply higher gasoline prices, in the wake of the hurricanes, triggered the steepest drop in consumer confidence in more than 25 years.  In November and December, consumer confidence had rebounded amid normalising gas prices.  However, rising gas prices in January have shaken consumer confidence in the first two months of the year.  According to the consumer survey, the rise and fall in gasoline prices have a huge impact on consumers’ perception of their financial situation and are the key factor behind the erratic shifts in consumer confidence.  While consumer confidence declined beyond market expectations, the current level still easily exceeds the 74.2 point low reached in October of last year.  Moreover, despite declining optimism, consumers spent briskly in early 2006, helped by unusually mild weather and gift card redemptions.   In January, retail sales jumped 2.3%, the biggest monthly increase since May 2004 and nearly triple the level projected by analysts.  Consequently, the US government remains optimistic about this year’s growth prospects, expecting the economy to expand around 3.5%.  Consensus Forecast participants share the government’s assessment and see the economy adding 3.4%, with a moderate decelerating trend throughout the year from 3.8% growth in the first quarter to 3.2% in the final quarter 2006.

Japan's economy accelerates beyond expectations in final quarter last year

The development in Japan sharply contrasted the sluggish performance of the U.S. economy towards the end of last year.  In the fourth quarter, gross domestic product expanded 1.4% over the previous quarter and 5.5% over the same period the year before in seasonally adjusted terms.  The actual reading exceeded expectations, which had the economy growing an annual 5.0% and was much faster than the paltry 1.4% annual expansion observed in the third quarter last year.  The third quarter had marked an exception in an unusually strong year with growth rates of 6.0% and 5.4% in the first two quarters.  As a result, full calendar-year growth reached 2.8%, the fastest pace since 2000.  In the fourth quarter, the economy fired up all cylinders, with strong contributions from the external as well as the domestic side of the economy.  Domestic demand more than doubled the third quarter pace amid strong private consumption.  However, investment continued to lose dynamism.  The contribution of the external sector jumped as exports accelerated, whereas imports dropped for the first time since the second quarter of 2003. 

Japan's consumer confidence rises to highest level since 1990

Unlike other recoveries in the past decade that proved to be short-lived, the current growth momentum is likely to carry over into this year, which would mark the third consecutive year with growth above the 2% threshold.  On 22 February, the government raised the economic outlook for the first time in six months.  Officials stated that the recovery in domestic private demand is likely to continue, as resilience in the corporate sector is extending into the household sector.  The latest economic indicators support the government’s increasing optimism.  According to the government’s consumer confidence survey of households with two or more people, the confidence index increased from 46.5 in December to 49.5 in January.  While confidence remained below the critical 50 level, where pessimists outnumber optimists, the reading represents the highest value registered since June 1990.  In fact, since 1982, the index has been only four times above 50.  Preliminary survey data suggest that business confidence among Japan's manufacturers also improved slightly in February, with the key sentiment index hitting the highest level since the survey was first published in June 1998.  Consequently, Consensus Forecast panellists have again revised the outlook for this year upward from 2.2% expected last month to the current 2.3%.  Moreover, unlike past rebounds that proved to be short-lived, the current recovery seems to taking a firmer hold with prospects also improving for the coming year, as economic growth is anticipated to reach 2.0%, up from 1.9% the last month.  The rekindling of the economy may even mean the end to deflation, which had held a grip over the economy for most of the past decade.  In January, producer prices rose at the fastest pace in 16 years and core consumer prices, which exclude fresh food, have risen for two straight months through December.  The Central Bank has pledged to keep its current accommodative policy until core inflation, which is the Central Bank's benchmark for conducting monetary policy, turns positive.  Monetary officials expect core inflation to “establish a rising trend' this year.  Consensus Forecast panellist share the Central Bank’s assessment and see inflation reaching 0.3% this year.

Optimism for Asia rises amid improved outlook for China, India and Japan

Asian growth prospects continue to improve.  Following on last month’s 0.3 percentage point upgrade to this year’s economic growth forecast for the region including Japan, Consensus Forecast panellists beefed up the outlook another tenth of a percentage point this month to 4.8%.  The regional average growth forecast for 2006 increased in spite of the weakening growth in the United States, a key factor determining demand for Asian exports.  However, the improved outlook for Japan should compensate for the slump in the United States.  Moreover, while U.S. consumer confidence has dipped slightly, it has reached an historic high in Japan, which suggests continued strong demand for consumer goods.  Given Asia’s function as a manufacturing hub for the global consumer goods industry, the region is set to profit from this trend and the recent upgrade reflects this.  The forecast for output growth in the regional economy excluding Japan also inched up 0.1 percentage points over last month to 7.0%.  The outlook to China increased from last month’s 8.8% to the current 9.0%, as a substantial upward revision to past national accounts data suggests that the Chinese economy is growing at an even faster pace than estimated earlier.  Meanwhile, consistent positive reports of new foreign direct investment in India’s production and service sector buttress optimism that the economy will continue to expand at a rapid pace in spite of an increasingly strained infrastructure.

Latin American outlook remains unchanged

The outlook for Latin American output growth this year remained unchanged over the past month, as upward revisions to two major economies were insufficient to compensate for unchanged prospects for the remaining five major economies in the regions.  None of the major countries was revised downward over last month.  As a result, the Consensus Forecast for GDP growth in 2006 for Latin America remained at the 4.0% expected last month.  Last year, Latin America expanded 4.0%, continuing a strong recovery initiated in 2004.  Argentina experienced an 0.2 percentage point upward revision to the 2006 GDP forecast.  Consensus Forecast panellists raised their forecast for the seventh consecutive month from 3.9% expected in August to the current 6.4%.  The second country to experience an upgrade was Colombia, which is expected to expand 4.3% this year, a notch better than the 4.2% growth expected last month.