Latin America in a Global Context - Economic Briefing May 2006

U.S. Rebound and Japan Lift Global Outlook

The global economic outlook looks increasingly positive. The U.S. economy is rebounding strongly from a bout of weakness and consumer confidence remains solid in spite of high energy prices. In Japan, the outlook continues to improve as recent economic reports suggest that the current recovery is even stronger than anticipated. Moreover, consumer confidence is reaching historic highs, which suggests that the domestic economy will fuel the recovery in the months ahead. Non-Japan Asia will grow at a vigorous pace and the region is set to remain the world’s fastest expanding economic area, as the regional behemoths, China and India, continue to grow at an unrelenting pace. Finally, even the Euro Area that has represented a major drag to global economic growth during the past years is showing incipient signs of revival. 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 rebounds strongly in first quarter

According to advance estimates released on 28 April, gross domestic product (GDP) increased at an annual rate of 4.8% in the first quarter, the fastest pace since the third quarter of 2003.  The expansion was in line with expectations, which had been ratcheted up as resilient retail sales and other indicators had suggested a strong first quarter.  The first quarter reading represents a significant rebound from the anaemic 1.7% growth registered in the final quarter last year.  The fourth quarter had marked the slowest growth pace since 2002 and interrupted a string of ten consecutive quarters with economic growth exceeding 3%.  The first quarter rebound was mainly due to a recovery in private consumption, which bounced from a lacklustre 0.9% growth in the fourth quarter last year to a 5.5% expansion in the first quarter.  The recovery in private consumption mainly reflects a strong rebound in durable goods, where a double-digit contraction in the fourth quarter turned into a double-digit expansion.  In addition, business investment also picked up notably over the 4.5% fourth quarter growth and expanded by 14.3%, the fastest pace in almost six years. 

Consumer confidence falters amid high gasoline prices

The duration of the first quarter upswing depends largely on consumer spending, which in turn hinges on consumer confidence.   In April, the University of Michigan’s consumer sentiment index dropped to 87.4 from 88.9 in March.  The market had expected consumer confidence to rise slightly to 89.0.  The reading continues a series of erratic shifts initiated in the wake of the hurricanes in September last year, when sharply higher gasoline prices triggered the steepest drop in consumer confidence in more than 25 years.  Since then, the fluctuations in gasoline prices have had a huge impact on consumers’ perception of their financial situation and are the key factor behind the erratic shifts in consumer confidence.  If gasoline prices are indeed the yardstick for consumer confidence, the recent spike in gasoline prices suggests that confidence and consumer spending are likely to falter.  The Federal Reserve shares consumers’ concerns and considers a sustained period of very high oil prices as the key risk to economic growth next to a big slump in the housing market.  The Fed recently indicated that the current tightening cycle with 15 interest rate increases during the past two years might be drawing to an end after one more interest rate increase. Regarding economic developments, the Fed expects growth to moderate in the coming quarters but to remain healthy.  Consensus Forecast participants share the Fed’s cautious optimism and anticipate a moderate deceleration to 3.4% growth in the second quarter and for growth to remain at that level virtually unchanged until the end of the year. 

Japan's economy poised for robust growth

First quarter growth data have not yet been published for Japan.  However, preliminary indicators suggest that while the 5.4% growth pace registered in the fourth quarter cannot be sustained, the economy will continue to grow at a robust pace.  According to the government’s consumer confidence survey of households with two or more people, the confidence index increased from a revised 47.9 in the fourth quarter last year to 48.2 in the first quarter in seasonally adjusted terms.  While confidence remained below the critical 50 level, where pessimists outnumber optimists, the reading represents the highest value registered since June 1991.  In fact, since 1982, the index has been above 50 only four times.  Business survey data suggest that business confidence among Japan's manufacturers held close to a one-year high and companies plan to step up investment.  The Central Bank’s Tankan index fell to 20 points from 21 points in December.  However, companies were a bit more optimistic about the months ahead as the economy enjoys a steady recovery and is emerging from deflation.  In fact, large Japanese companies plan to increase spending 2.7% this year, which represents the strongest value in a March survey since 1990, according to the Central Bank.  Consequently, Consensus Forecast panellists have again revised the outlook for this year upward from 2.7% expected last month to the current 2.8%.  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 2.1%.  The rekindling of the economy is also likely to overcome deflation, which has held a grip of the economy for most of the past decade.  In March, annual core consumer price inflation, which excludes fresh food, remained at 0.5% for the third consecutive month.  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 amid expectations that core inflation would establish a rising trend this year.  Consensus Forecast panellist share the Central Bank’s assessment and see inflation reaching 0.4% this year.

Improving 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 0.1 percentage points this month to 5.1%.  The regional average growth forecast for 2006 increased amid a strong rebound in the United States, a key factor determining demand for Asian exports.  Moreover, the outlook for Japan continues to improve and increasing consumer confidence suggests that Japanese consumers will add to strong demand growth.  The upgrade also reflects Asia’s function as a manufacturing hub for the global consumer goods industry, as the region is set to profit from the current upward trend.  With Japan accounting for almost half of Asian output, any upward revision applied by Consensus Forecast panellists has a significant impact on the regional average.  In fact, the forecast for output growth in the regional economy excluding Japan remained unchanged over last month at 7.1%.  The outlook for China increased from last month’s 9.1% to the current 9.2%, as strong first quarter growth suggests that the government’s intention to slow the pace of economic expansion will prove futile.

Growth outlook for Latin America revised upward amid upward revisions to Argentina and Mexico

The outlook for Latin America also improved over the past month.  Since the 4.1% expansion projected in April, Consensus Forecast panellists revised the growth forecast for Latin America upward by 0.1 percentage points to 4.2%.  Thus, the Latin American region will experience yet another year of above average growth, following on last year’s 4.0% expansion.  In fact, apart from 2004, this year’s expansion would represent the highest rate since 1997.  This month, an improved growth forecast for three of the seven major economies lifted the regional outlook.  The outlook of four countries remains unchanged and no country was revised downward over last month.  The most important contribution to this month’s improved outlook comes from Mexico.  While the 2006 GDP growth forecast inched up only one tenth of a percentage point over last month to 3.7%, Mexico accounts for almost one third of total regional output, which helped to lift the growth forecast for the entire region.  The upward revision in Mexico was mainly motivated by the strong first quarter rebound in the United States.  With almost 90% of all exports directed to the United States, Mexico is the most likely Latin American economy to benefit from faster growth in the United States.  Next to Mexico, Argentina, Latin America’s third largest economy, experienced a 0.1 percentage point upward revision to the 2006 GDP forecast.  Consensus Forecast panellists raised their forecast for the tenth consecutive month from 6.8% expected in April to the current 6.9%.  Following on three years of strong growth, most economists had expected the growth pace to moderate, as the cyclical rebound from the preceding recession is drawing to an end.  However, even though economic activity added an average of 9.0% annually in the past three years, the devastating recession that held its grip over the economy for full four years has provided for more cyclical recovery potential than anticipated.