Latin America in a Global Context - Economic Briefing April 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 1.7% according to final 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 the first quarter 2003 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 sluggish durable consumer goods (-16.6% year-on-year), 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 rebounds

Consumer confidence bounced back more than expected.  In March, the University of Michigan’s consumer sentiment index increased to 88.9 from 86.7 in February.  The market had expected consumer confidence to rise to 86.9.  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, only to fall back again when the price trend turned.   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 rose beyond market expectations in March, the current level still below the average confidence level observed last year.  However, despite subdued optimism, consumers continued to spend briskly in early 2006.  After an unusually mild weather had boosted retail sales in January, retail sales increased yet again in February, suggesting a strong recovery of private consumption in the first quarter.  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 3.5%, 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

In the fourth quarter, gross domestic product (GDP) expanded 1.3% over the previous quarter and 5.4% over the same period the year before in seasonally adjusted terms, according to revised national accounts data.  The reading was a notch below the preliminary 5.5% growth figure but exceeded market expectations, which had expected the government to revise initial estimates downward to 5.0%.  Moreover, the final quarter reading was much faster than the paltry 0.8% 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 5.5% and 5.7% in the first two quarters.  As a result, full calendar-year growth reached 2.7%, 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 tripled the third quarter pace amid strong private consumption.  However, investment continued to lose dynamism and was actually flat over the same period the year before.  The contribution of the external sector jumped as exports accelerated, whereas imports dropped for the first time since the second quarter of 2003.  The strong fourth quarter reading and the most recent indicators suggest that the current recovery is sustainable.  Consensus Forecast panellists expect the economy to grow 2.7% this year, which is up 0.4 percentage points over last month’s forecast.

Bank of Japan ends ultra-loose monetary policy

Strong economic growth and recent increases in consumer prices prompted monetary authorities to end the five-year deflation-fighting policy.  On 9 March, the Bank of Japan (BoJ) announced  the end of the “quantitative easing” monetary policy and the return to a conventional interest rate regime.  The decision was largely expected, however,  the timing came as a surprise as the announcement was expected for later this year.  The BoJ first adopted the quantitative easing policy in March 2001, following two years of declining prices, in order to support the deteriorating economy by adopting a more aggressive monetary policy approach than just keeping interest rates at zero.  Under the quantitative easing policy, the BoJ set a target for the amount of money that it force-fed into the banking system.  To that end, the BoJ purchased substantial amounts of government bonds, leaving Japanese banks with large stocks of excess reserves.  Currently, the target for bank balances is between 30 and 35 trillion yen (US$ 255 - US$ 298 billion) - five to six times the legally required reserves, which total about 6 trillion yen.  The rationale behind quantitative easing was that banks with excess liquidity are less likely to face liquidity problems due to an unexpected adverse shock and would therefore be willing to lend more.  The BoJ now faces the challenge to unwind the excess liquidity without derailing the economic recovery.  In fact, the government has cautioned the Central Bank against tighten the monetary reins too early.  In August 2000, monetary authorities had prematurely ended an 18-month-long zero interest rate policy and the economy slipped back into recession.  Even though the recession was mostly related to the burst of the dot-com bubble, the BoJ took part of the blame.  Therefore, the Central Bank announced a continuation of government bond purchases “for some time” and that interest rates will be kept around zero for the time being.  In addition, the BoJ announced a new framework for monetary policy and defined its understanding of medium- to long-term price stability as an approximate range between 0% and 2%. In January, both, annual headline and core inflation stood at 0.5% and were thus consistent with the Central Bank’s understanding of price stability, which does not constitute a target.  Consensus Forecast panellists share the Central Bank’s optimism that deflation has been left behind for good and expect consumer prices to rise 0.3% this year and 0.6% next year.

Better outlook for Asia amid upgrades to Japan and China

Asian growth prospects continue to improve.  Following on last month’s 0.1 percentage point upgrade to this year’s economic growth forecast for the region including Japan, Consensus Forecast panellists beefed up the outlook another 0.2 percentage points this month to 5.0%.  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 remains well below its maximum, it has reached a 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.  Increasing optimism about economic recovery in Japan accounted for the lion share of this month’s upgrade.  With Japan accounting for almost half of Asian output, the 0.4 percentage point upward revision applied by Consensus Forecast panellists had a significant impact on the regional average.  The forecast for output growth in the regional economy excluding Japan only inched up 0.1 percentage points over last month to 7.1% and was primarily driven by the better outlook for China, which increased from last month’s 9.0% to the current 9.1%.

Latin American outlook improves amid upward revisions to most countries

The outlook for Latin America is slowly improving.  Compared to last month, all major economies except Colombia experienced an upward revision, pushing the Consensus Forecast for GDP growth in 2006 in Latin America from 4.0% to 4.1%.  Last year, Latin America expanded 4.0%, continuing a strong recovery initiated in 2004.  With 0.4 percentage points, Argentina experienced the highest upward revision to the 2006 GDP forecast.  Consensus Forecast panellists raised the growth forecast for the eighth consecutive month from 3.9% expected in August last year to the current 6.8%.  Apparently, the country still has not lived up to its potential for cyclical rebound in spite of having expanded above 8% annually for three full years.  Meanwhile, the upgrade to Mexico’s outlook was more moderate.  Consensus Forecast panellists lifted the projection for economic growth this year from 3.5% expected last month to 3.6%.  The upgrade reflects a more resilient than expected first quarter recovery in the U.S. economy and a positive impetus emanating from a looser monetary policy, as the benign inflationary environment is permitting the Central Bank to continue cutting interest rates.