Latin America in a Global Context - Economic Briefing October 2006

Outlook for Latin America Improves Again

The outlook for the global economy remains positive for this year but is showing signs of a slowdown in 2007. While oil prices have declined amid abating tensions in the Middle East, the end of the housing boom in the United States could weaken private consumption, one of the key pillars of global consumption. In fact, the U.S. economy is already slowing, following on a strong but temporary rebound earlier this year. However, consumer confidence is picking up again and could provide for a recovery of consumption in the months ahead. The Japanese economy also slowed notably but consumer confidence is remaining close to historic highs, which suggests that the domestic economy will fuel the recovery. Moreover, non-Japan Asia will continue to grow at a resilient rate, as the two leading economies of the region, China and India, continue to grow at an unrelenting pace. Finally, prospects for Latin America improve again, as the region profits from a drawn out upward cycle in commodity prices.

Final growth estimates confirm U.S. slowdown in second quarter

According to final estimates released on 28 September, gross domestic product (GDP) increased at an annual rate of 2.6% in the second quarter.  Second quarter growth came in below  the 2.9% reported on 30 August and represents a significant slowdown from the resilient 5.6% growth registered in the first quarter and thus continues the erratic growth pattern observed during the past quarters.  The first quarter had marked the fastest growth in more than two years and represented a strong rebound from the anemic 1.7% growth registered in the final quarter last year, when the economy grew at the slowest pace since 2002.  The second quarter slowdown was broad-based and reflected a deceleration in consumption as well as in investment.  Private consumption slowed to almost half the 4.8% pace observed in the first quarter and increased 2.6% annually in seasonally adjusted terms.  The slump in private consumption mainly reflects a pronounced dip in durable goods, where a 19.8% expansion in the first quarter turned into a 0.1% contraction in the second.  Consumption expenditures of services, in contrast, accelerated notably but were not sufficient to compensate for the slowdown in durable consumer goods.  Investment in equipment and software dropped 1.4% over the same period last year, the first decline registered in more than three years. 

Fed faces economy with rising inflation and slower growth

While a deceleration from the vigorous first quarter pace was generally expected, the size of the slowdown surprised to the downside.    Moreover, Consensus Forecast panellists see the economy remaining sluggish in the coming months, expanding 2.2% in the second half of the year.  However, the latest consumer confidence data suggest that consumption could have picked up again in the third quarter.  In September, the University of Michigan’s final reading of the consumer sentiment index was 85.4, well above August’s reading of 82.0.  In addition, consumer expectations jumped from 68.0 in August to 78.2 in September.  Consumer confidence continues to hinge largely on the development of gasoline prices and the recent declines in gas prices as well as the strengthening labour market have lifted confidence to current levels.  Moreover, consumers are convinced that inflation will revert to lower levels over the longer term, which has helped to buttress consumers’ optimism.  This view, however, is not supported by the latest data.  In August, the core consumer price index, which measures consumer prices excluding food and energy, increased 2.8% annually.  While only marginally ahead of July’s 2.7% reading, core inflation increased for the fifth consecutive month.  The data suggests that inflation could continue to spread beyond energy through the rest of the economy, even as economic growth slows.  The diverging developments of the slowing economy on the one hand and accelerating inflation on the other hand, highlight the dilemma of monetary policy makers.  So far, the Federal Reserve has put the emphasis on fighting inflation, raising interest rates 17 consecutive times since June 2004 until June this year.  However, at the last two policy meetings the Federal Open Market Committee (FOMC) voted to keep the benchmark federal funds rate unchanged at 5.25%.  The FOMC said economic growth has moderated, reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.  Furthermore, the Fed stated that even though inflation readings have been elevated in recent months, price pressures seem likely to moderate over time.  However, the Committee judged that some inflation risks remain and claimed that additional firming may be needed to address these inflation risks.  Consequently, policy makers could well opt to hike rates yet another time in the upcoming October meeting.

Japan's economy closer to deflation after statistical revision

In the second quarter, gross domestic product expanded 0.2% over the previous quarter and 1.0% over the same period the year before in seasonally adjusted terms, according to second preliminary national accounts data.  The second quarter reading was slightly above the first preliminary estimates from August, which had stated a 0.8% annual growth rate.  However, the reading was well below the 3.3% annual growth reported for the first quarter, which was revised upwards from the 2.7% growth reported previously.  In spite of the slowdown in the second quarter, the outlook remains solid, as preliminary indicators suggest that the economy has picked up speed again in the third quarter.  According to the government’s consumer confidence survey of households with two or more people, the confidence index declined from 48.6 in July to 47.6 in August.  Thus, confidence fell even further below the critical 50 level, where pessimists outnumber optimists.  However, the index remains high in comparison to the last years.  In fact, since 1982, the index has been only four times above 50.  Moreover, a recent business confidence report showed that confidence among the country’s largest manufacturers unexpectedly rose to a two-year high in September and companies plan to increase spending at the fastest pace in 16 years.  Consequently, Consensus Forecast panellists remain upbeat that the current recovery will continue and expect the economy to grow 2.6% this year, which is only a notch below last month’s 2.7% forecast.  Moreover, the panel is optimistic that the recovery will continue into next year, with the economy expanding at a more moderate but still positive pace of 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.  However, owing to a revision of the base year of the consumer price index, restated annual core inflation fell below the 0.6% reported earlier for June and July.  The 0.3% annual core inflation rate now reported for August renders further interest rate hikes less likely.  The Central Bank recently ended over five years of zero interest rates and raised the key overnight call rate target by 25 basis points to 0.25% in mid-July.  While the Bank of Japan (BoJ) indicated that it would continue to raise interest rates gradually in light of economic developments, monetary authorities pledged that they would probably keep rate hikes very low for some time.  In fact, on 8 September, the Bank decided to keep its overnight lending rate at 0.25%.  The BoJ judged that the economy is not expanding fast enough to warrant a second increase in two months.  Next to political pressures to keep interest rates low, the Bank is likely to act cautiously after its rate hike in August 2000 allegedly contributed to squash an incipient recovery of the economy.  The BoJ expects consumer prices to rise 0.6% this fiscal year, which ends next March, and to increase 0.8% in the coming fiscal year, ending March 2008.  Consensus Forecast panellists mainly share the Central Bank’s assessment and see inflation reaching 0.4% in 2006 and 0.6% in 2007.

Outlook for Asia improves amid growing optimism for China and India

Asian growth prospects continue to improve.  Following on seven upward revisions during the past nine months, Consensus Forecast panellists beefed up this year’s economic growth forecast for the region including Japan another 0.1 percentage points this month to 5.4%.  The regional average growth forecast for 2006 increased in spite of increasing risks that U.S. consumption, one of the key growth drivers in the export-dependent Asian economies, might slow in the months ahead.  In particular, a less dynamic U.S. housing sector causes concerns, as a diminished wealth level could prompt American consumers to act more cautiously.  This month, upward revisions to economic growth in six of the twelve economies surveyed are mitigated by four downward revisions and unchanged outlooks in the remaining two countries.  Once more, China is the key reason for the more optimistic prospects for the entire region.  Since China accounts for almost one quarter of total regional output, any shift in the economic assessment has a notable impact. Consequently, this month’s 0.3 percentage point upward revision to the 2006 GDP forecast to 10.2% was more than sufficient to compensate for weaker projections for Korea, Taiwan, Thailand and Vietnam.  However, in China, the government’s measures to slow the resilient economic expansion are beginning to show some effect and investment is growing at a strong but less dynamic pace than previously.  Consensus Forecast panellists are also more upbeat about India and revised their projections from 7.6% last month to the current 7.8%, as better than expected economic growth data suggest a more vigorous growth this year.  Next to China and India, Hong Kong, Indonesia, the Philippines and Singapore experienced notable upward revisions to their GDP forecast.  On the downside, Consensus Forecast panellists pared the outlook for Thailand even though the military coup is not expected to have a notable downside effect on the economy.  Taiwan and Vietnam are joining Thailand with weaker forecasts compared to last month.

Outlook for Latin America improves amid upward revisions to most economies

The outlook for Latin America also improved over the past month.  Since the 4.4% expansion projected in September, Consensus Forecast panellists revised the growth forecast for Latin America upward by 0.2 percentage points to 4.6%.  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 five of the seven major economies lifted the regional outlook.  The outlook of the two remaining countries declined and no country was unchanged over last month.  The two regional behemoths, Brazil and Mexico, balanced each other, as a downward revision to Brazil, Latin America’s biggest economy, was precisely offset by an upward revision to Mexico, the region’s second largest economy.  Consensus Forecast panellists lowered the 2006 GDP growth forecast for Brazil from 3.5% expected last month to the current 3.3%, as economic data continue to disappoint.  On a positive note, the benign inflation environment enables the Central Bank to loosen monetary policy, which will stimulate growth once the lagged beneficiary effect of interest rate cuts kicks in.  Chile also experienced a 0.2 percentage point downward revision this month, following signs that the economy is loosing some of the momentum that has been fuelling the current business cycle.  Nevertheless, with 5.2% output growth expected for this year, Chile will experience yet another year of solid growth.  The outlook for Mexico, in contrast, was revised upwards as the recovery experienced in the first half of the year provides a more solid backdrop for the remainder of the year.  Nevertheless, the economy will loose momentum in the months ahead, in particular if the anticipated slowdown in the United States materializes.  In Argentina, Consensus Forecast panellists raised their forecast eleven times during the past twelve months, culminating in the current 7.6% forecast.  However, Argentina looses the spot as the fastest growing economy in the region, which it had kept until last month to Venezuela.  In spite of the rapid decline in oil prices observed during the past two months, the outlook of the leading oil exporter of the region was beefed up by 1.4 percentage points from 6.8% growth expected last month to the current 8.2% forecast.  Apparently, the windfall profits from the oil sector are passed on generously to the non-oil economy by a government eager to please the electorate ahead of the December elections.