Latin America in a Global Context - Economic Briefing June 2006

Global Outlook Remains Solid in Spite of High Oil Prices

The global economic outlook remains positive. However, the steep oil price increase continues to overshadow prospects. While the U.S. economy is rebounding strongly from a bout of weakness earlier this year, consumer confidence plummets amid high energy prices, denting the prospects of an ongoing consumption boom. In contrast to the United States, Japanese consumer confidence is reaching historic highs, which suggests that the domestic economy will fuel the recovery in the months ahead. Nevertheless, the series of upward revisions to the growth outlook is drawing to an end. 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. 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. growth revised upwards as economy rebounds strongly in first quarter

According to preliminary estimates released on 25 May, gross domestic product (GDP) increased at an annual rate of 5.3% in the first quarter.  The reading represents a 0.5 percentage point upward revision from the 4.8% advance estimate released last month but was in line with expectations, which had been ratcheted up in the recent past as resilient retail sales and other indicators had suggested a strong first quarter.  The first quarter reading represents the fastest pace since the third quarter 2003 and is 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 in excess of 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 5.2% expansion in the first quarter.  The recovery in private consumption primarily 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 13.1%.

Fed tightens while consumer confidence plummets amid high gasoline prices

The current pace of economic growth is clearly unsustainable.  In particular, the fast growth in durable consumer  goods, which expanded by 20.5% over the same period last year will certainly give way to a more moderate rhythm as it mostly reflects a rebound from a very weak preceding quarter.  Moreover, consumer confidence, the key determinant for purchasing decisions, weakened.   In May, the University of Michigan’s consumer sentiment index dropped to 79.1 from 87.4 in April.   The May reading represents the lowest level of consumer confidence since September last year, when sharp increase in gasoline prices triggered the steepest drop in consumer confidence in more than 25 years.  Higher gasoline prices also seem to be behind the May plunge in consumer confidence.  In fact, since September last year, 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.  By 22 May, gasoline prices have reached to US$ 2.88 a gallon, up more than a third so far this year and close to the highest level in eight months.  The steep gas price increase is countering the positive effects of rising wages and an unemployment rate that is approaching a five-year low.  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.  Nevertheless, the Fed continued the current tightening cycle, raising interest rates for the 16th consecutive time on 10 May.  Monetary officials did indicate, however, that future decisions on interest rates will hinge more heavily on the development of economic activity and inflation.  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 3.5% growth in the second quarter and for growth to remain at that level virtually unchanged until the end of the year. 

Japan's economy slows in first quarter but remains poised for ongoing recovery

In the first quarter, gross domestic product expanded 0.5% over the previous quarter and 1.9% over the same period the year before in seasonally adjusted terms, according to first preliminary national accounts data.  The reading was well below the 4.3% annual growth reported for the previous quarter but exceeded market expectations, which saw the economy growing by 1.1% just prior to the release.  In part, the first quarter slowdown represents a strong acceleration in imports, which reduced the net contribution of the external sector to zero.  In the fourth quarter, net exports had accounted for half of total economic growth.  Private consumption held up relatively well, slowing from 2.5% annual growth in the fourth quarter to 1.6% in the first quarter.  Preliminary indicators suggest that consumption will again pick up speed in the current quarter.  According to the government’s consumer confidence survey of households with two or more people, the confidence index increased from 47.9 in March to 50.0 in April.  Thus, confidence just reached the critical 50 level, where the number of pessimists equals the number of optimists.  The reading represents the highest value registered since June 1991.  In fact, since 1982, the index has been above 50 only four months.  Nevertheless, Consensus Forecast panellists have ended their series of upward revisions observed since and have revised the outlook for this year downward by one tenth of a percentage point from 2.8% expected last month to the current 2.7%.  That said, unlike past rebounds that proved to be short-lived, the current recovery seems to be taking a firmer hold with prospects also improving for the coming year, as economic growth is anticipated to reach 2.1%.  Moreover, the rekindling of the economy is likely to overcome deflation, which has held a grip of the economy for most of the past decade.  In April, annual core consumer price inflation, which excludes fresh food, remained at 0.5% for the fourth consecutive month.  As a result, the Central Bank is increasingly preparing financial markets for monetary tightening.  On 9 March, the Bank of Japan (BoJ) had announced the end of its ultra-loose monetary policy and the return to a conventional interest rate regime.  Consensus Forecast panellist share the Central Bank’s assessment and see inflation reaching 0.4% this year.

Outlook for Asian growth remains unchanged

Asian growth prospects remain solid but did not improve over last month.  Following on seven consecutive months with upward revisions to regional output growth projected for 2006, the forecast remained at 5.1% for the region including Japan.  The halt in the series of upward revisions reflects the slump in U.S. consumer confidence and a more cautious assessment of the recovery in Japan.  In fact, the outlook for Asia ex Japan improved by 0.2 percentage points over last month to 7.3%.  Once more, China is the key reason for the more optimistic prospects for the entire region.  Since China accounts for 44.1% of total regional output ex Japan, any shift in the economic assessment has a notable impact.  In 2006, China’s economy will grow 9.3% according to this month’s Consensus, 0.1 percentage points better than expected last month and the eighth consecutive monthly improvement.  Apparently, even the recently introduced government measures to slow the growth of credit and investment are considered insufficient to slow the underlying momentum of the Chinese economy.  Next to China; Singapore, Malaysia, Korea and Hong Kong experienced notable upward revisions to their GDP forecast, as the countries benefit from the solid global demand.

Latin American outlook remains unchanged

The outlook for Latin American output growth this year remained unchanged over the past month, as upward revisions to three major economies were insufficient to compensate for a downward revision to one country and unchanged prospects for another country.  As a result, the Consensus Forecast for GDP growth in 2006 for Latin America remained at the 4.2% expected last month, following on two months of consecutive upward revisions in April and May.  Last year, Latin America expanded 4.0%, continuing a strong recovery initiated in 2004.  Apart from 2004, this year’s expansion would represent the strongest expansion since 1997.  The most important upgrade this month comes from Mexico.  While the 2006 GDP growth forecast inched up only one tenth of a percentage point over last month to 3.8%, this month’s upgrade represents the third consecutive revision to the Mexican outlook, lifting the region’s second largest economy from 3.5% GDP growth expected in March this year to the current 3.8%.  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.  Chile is the only major economy that experienced a downward revision this month, following weaker than expected growth in the first quarter.  Nevertheless, with 5.6% output growth expected for this year, Chile remains one of the fastest growing economies in the region.