February 2, 2013
VANCOUVER, BC, Feb. 2, 2013/ Troy Media/ – Economic prospects in the global economy improved slightly with signs of faster growth in China and other Asian economies along with receding risks of a financial crisis in Europe.
The U.S. economic recovery continues to grind higher in the face of fiscal headwinds and potential political pitfalls. Europe’s economy remains in recession and is the main drag on global growth. Highly-stimulative monetary conditions in many economies will prevail through 2013, and in some cases, through 2014.
The surprising decline in fourth quarter U.S. real GDP does not presage a recession. Real GDP contracted by 0.1 per cent, down from 3.1 per cent growth in the third quarter, according to the government’s advance estimate. Slower growth was widely expected since the third quarter was propped up by a temporary surge in inventories and defense spending.
Exports and state and local spending fell while non-residential fixed investment and consumer spending growth accelerated. A decline in real GDP can mean a recession is underway but not in this instance since the decline is due to one-time events. There was no confirmation of recessionary developments in other economic indicators such as employment, industrial production, housing, and consumer spending expanded during the fourth quarter. Further, the revisions to the advance estimate could eliminate the decline.
Another measure of the economy’s condition is final sales to domestic purchasers. This measure is real GDP excluding inventories and in the fourth quarter expanded at a 1.3 per cent annual rate though down from 1.9 per cent in the third quarter.
A growth slowdown occurred in the fourth quarter but not into recession territory. The fiscal cliff deal reached on Jan. 1, 2013 included tax hikes for high-income taxpayers the expiration of the payroll tax holiday, and higher capital gains, dividend income and estate taxes. The deal did not cut spending or the debt ceiling and a deal was delayed until March when another round of political brinksmanship will likely play out, raising financial market distress. Further postponements to reach a deal would not be surprising.
No recession is predicted in the short-term according to the index of leading indicators. It increased 0.5 per cent in December and has risen in three of the previous four months. However, some weakness is likely for manufacturing in January since the regional Fed surveys were negative. As an offset, Hurricane Sandy rebuilding will increase first quarter GDP growth.
Moderate growth will continue in 2013 with real GDP expanding between 2.0 per cent and 2.5 per cent on gathering momentum during the year with growth reaching about 3 per cent in the fourth quarter. The following year looks more promising, with growth in the 3.0 per cent to 3.5 per cent range.
Housing, business investment, and exports will play a leading role in the coming growth upturn while further federal spending cuts and higher payroll taxes act a as a drag on the economy.
China’s economy picked up in the second half of 2012 and headed into 2013 on a positive tone. Policy stimulus in the form of interest rate cuts, increased credit supply, and accelerated spending on infrastructure helped avoid a hard landing and boosted the economy. The economy grew 7.8 per cent in 2012, slightly above the official 7.5 per cent target.
January’s HSBC China manufacturing PMI rose for the fifth consecutive month to the highest level in two-years. There is an inventory restocking process underway, which will lift industrial production though is not an enduring growth source. Should growth falter below the government’s target, it will administer additional stimulus.
China’s economic growth is forecast at 8.1 per cent in 2013 and 8.0 per cent in 2014. A return to 10 per cent annual growth needs stronger U.S. and European demand for China’s products. However, with China and other Asian economies on a firmer growth path, the global economy is on a sounder more certain footing.
Europe’s economy struggles in its second recession in three years. The recession is spreading to the core countries like Germany and France while the peripheral countries flounder is deeper recessions.
The policy moves of last year reduced the risk premium on sovereign bond yields but more measures are needed. Spain has serious fiscal problems and may need to access the rescue fund. Credit conditions remain very tight for mortgage and consumer credit as well as for business, restraining growth. Fiscal austerity measures exacerbated the recession but were a necessary dose of medicine.
The focus among policymakers is beginning to shift to growth-promoting policies. The ECB may well cut rates, or more likely, shift to a more dovish communication message, i.e., jawbone down lending rates.
The near-term outlook is bleak. The January PMI survey continues to signal falling activity. For the year as a whole, real GDP is predicted to shrink or eke out a small gain on the heels of an estimated 0.5 per cent contraction in 2012. The Euro area economy may return to growth later this year but credit conditions need to improve and no political or debt crisis emerge. Europe seems destined for modest growth after the recession.
Canada’s economic slowdown is around the midway point based on the most recent indicators and on the outlook for the U.S. and global economies. Below-trend growth in fourth quarter real GDP will occur with first quarter 2013 growth closer to trend. Mixed trends across key sectors reflect the economy’s modest overall growth.
The labour market surprised to the upside with nearly 90,000 net jobs added in November and December and 145,000 jobs since September. Overall job growth in 2012 was just above 200,000 jobs or 1.2 per cent. While there is no one-to-one relationship between job growth and real GDP growth, these strong job numbers imply a growth pickup.
Industry GDP growth rose 0.3 per cent in November up from 0.1 per cent in October following declines in three of the prior four months. Most industry sectors gained in November with a notable rebound in manufacturing. Retail sales increased for the fifth consecutive month, rising 0.2 per cent and 0.8 per cent in volume terms during November. Higher motor vehicle sales accounted for the strong performance and, excluding vehicle sales, retail sales declined 0.3 per cent though volume still increased. Lower prices for imported goods and energy lifted volume.
The housing market softened further with sales down in December and down in the seven of the past eight months. Housing prices have topped and housing starts are beginning to turn down. This mild correction phase will last a few more months until the economy picks up and consumer confidence strengthens. The housing sector will no longer contribute to economic growth and instead act as a drag on growth during this correction period.
Exports are another weak spot in the economy. The global and U.S. slowdown knocked down third quarter exports, and another decline is shaping up so far in the fourth quarter. Energy and metal/non-metallic mineral products account for most of the weakness while motor vehicles and parts exports expanded more than 10 per cent.
In the near term, growth will pick up according to the gains in the composite leading index in November and December. The financial components of the index bolstered these gains along with the labour market. Not surprisingly, the housing component fell.
The Bank of Canada released its latest forecast update and downgraded its view from last October. Instead of 2.2 per cent growth in 2012, it now expects 1.9 per cent and in 2013, instead of 2.3 per cent, the Bank expects 2.0 per cent. Interestingly, the Bank revised 2014 growth up to 2.7 per cent from 2.4 per cent.
The forecast quarterly growth profile is revealing in that a rising trend commences with the first quarter of 2013 of 2.3 per cent and continues to 2.9 per cent in the second half and 2.8 per cent in the first half of 2014 before settling down to 2.3 per cent in the fourth quarter of 2014. This growth profile is consistently above the private sector consensus.
Since the Bank’s operational target is 2 per cent inflation, it usually presents a growth forecast that closes the output gap with 2 per cent inflation at the end of its forecast horizon. Above consensus growth forecasts closes the output gap.
The forecast output gap begins to narrow more quickly in the third quarter and essentially closes in the third quarter of 2014. Since the Bank will act in advance of this closing by about nine months, it appears the first rate hike could occur in the fourth quarter of 2013. Of course, this is contingent on the economy unfolding largely as forecasted. Fourth quarter real GDP is forecast at 1.2 per cent, slightly lower than consensus (1.4 per cent) but higher than the Bank of Canada’s 1.0 per cent.
For all of 2013, growth is forecast at 2.0 per cent and for 2014 at 2.8 per cent. The consensus puts growth at 1.8 per cent in 2013 and 2.4 per cent in 2014.
Consumer price inflation in Canada held at 0.8 per cent y/y in December, the same as in November. The seasonally adjusted CPI decreased 0.1 per cent in December following a 0.2 per cent decline in November. Lower gasoline and natural gas prices, low mortgage interest costs, and lower costs for clothing helped to lower the inflation rate. The Bank of Canada’s core inflation rate edged down to 1.1 per cent y/y from 1.2 per cent in November.
Long bond yields moved higher during January on positive economic news from the U.S. and China. Avoiding the plunge off the fiscal cliff also lifted market sentiment. The increase over December ranged from 10 basis points at two-years to 30 bps at 10-year governments. There was no material change at the short-end of the yield curve since those rates are anchored by the Bank of Canada’s target rate. Administered one-year and three-year mortgage rates notched down slightly since November.
There was no change in the Bank of Canada’s overnight rate at its January meeting. The Bank sounded more dovish in its future guidance stating, ‘the withdrawal of stimulus is less imminent than previously anticipated.’ Nonetheless, the Bank is keen on moving rates higher from this very low level.
Interest rate forecast
No rate change is expected at the next Bank of Canada meeting or in 2013 but rather at the first meeting in 2014. Economic conditions requiring the removal of monetary stimulus are not likely to materialize until early 2014. There is a chance the Bank will move in the fourth quarter of 2013 or possibly earlier since it seems anxious to pull the trigger. It is a close call. The futures market for three-month Bankers Acceptances does not factor in the first 25 bps increase until the second quarter of 2014. The consensus view of forecasters puts the first increase in the fourth quarter of 2013. Administered rates look to hold at current levels in the near term before upward pressure at the long end emerges around mid-year and in the summer. The softening housing market could nudge mortgage rates lower as competition becomes stiffer.
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