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Increased pessimism amid war
concerns
The outlook for global economic growth continues to deteriorate. The
forecast for aggregate global growth for 2003 was lowered a notch since
last month to 2.7%. With less than two months left, the outlook for this
year was maintained at 1.8%. The outlook for the coming year was lowered,
as uncertainty about a military conflict with Iraq continues to loom.
However, the latest developments, a toned down UN resolution approved by
the Security Council on 8 November that reduces the likelihood of a
military outcome considerably, has not yet fed through into the forecasts.
Consequently, the current forecast may mark the bottom, provided new
shocks to global economy remain absent.
US economy growing at healthy pace
in third quarter but slowdown ahead as …
In the third quarter, US gross domestic product (GDP) increased at an
annual rate of 3.1%, according to advance estimates released by the Bureau
of Economic Analysis (BEA). The growth rate was below market expectations
of 3.6% but above second quarter expansion of 1.3%. The main drivers
behind third quarter growth were personal consumption expenditures (PCE),
equipment and software, government spending, and exports. The
contributions of these components to growth were partly offset by a
decrease in non-residential structures and by higher imports.
The growth registered in the third quarter is not bad for an economy
facing considerable declines in equity markets, which threaten to
undermine the buttress of the economy, the American consumer. Consumption
still grew at a healthy pace in the third quarter but most analysts expect
a considerable slowdown in the final quarter of the year, as economic data
point towards a weak start into the fourth quarter. Car sales, which have
proven surprisingly resilient due to continued sales incentives offered by
the industry, are beginning to soften. Payrolls dropped and unemployment
rose to 5.7%, while the factory index of the Institute for Supply
Management (ISM) remains below the 50 point threshold, which indicates
that the manufacturing sector may be tipping back into a recession.
… consumer confidence reaches lowest
level in years, as confidence in economic policy erodes and Iraq conflict
looms
Moreover, political events are also eating away at consumer confidence, as
a military conflict with Iraq looms. In normal times, such a military
conflict, far away from the United States and against an adversary
weakened over the past decade, would not be of great concern for markets.
However, the events of 11 September and even the locally confined sniper
attacks have shown the potential scope of a backlash that military action
could have on consumption. In addition, a conflict in the Middle East
would threaten to boost the oil price further and thus could limit the
manoeuvring room for monetary stimulation. The most recent developments
have rendered a military conflict less likely than only a couple of weeks
ago but the uncertainty over a military or peaceful solution of the U.S.-Iraq
conflict remains high. Given the potential damage that a military solution
would have on the global economy, economists appear to be basing their
outlook on the developments on the political front, with scenarios ranging
from a simple Iraq acceptance of a UN resolution and adherence to its
terms to a protracted military conflict that could potentially spread
through the whole Middle East with all possible scenarios in between. In
the optimistic case, oil prices, which currently include an “Iraq conflict
risk premium” of US$ 3 to US$ 5 could drop again and the world economy
could proceed unperturbed as early as first quarter 2003. The conflict
scenario might bring substantially higher oil prices – pessimistic
estimates see the per-barrel price even above US$ 40 – and a protracted
downside pressure on economic activity around the globe. The latest
consumer confidence surveys reflect the possibility of such an outcome.
The October consumer confidence index of the University of Michigan
plunged to the lowest level recorded since 1993, prompted by a slowing
economy, lower household wealth, and apprehensions about the possibility
of war with Iraq. According to the survey report, the accumulated loss in
consumer confidence could tip the economy back into recession, unless the
downward momentum is quickly halted. The survey moreover states that
consumers’ confidence in government economic policies fell to the lowest
level since President Bush first entered office and that consumers might
act to curtail spending and increase their saving as a precaution against
the possibility of adverse developments in their financial situation.
Fed cuts interest rate to lowest
level in more than 40 years
On 6 November, the Federal Open Market Committee (FOMC) decided to lower
its target for the federal funds rate by 50 basis points to 1.25%. The
decision to ease — the first this year after 11 rate cuts in 2001 – was
generally expected, however, the market had anticipated a more moderate 25
basis point adjustment. The Committee explained its decision to adopt a
more accommodative monetary policy stance with its desire to help the
economy over the current “soft spot”, as heightened geopolitical risks are
currently inhibiting spending, production, and employment generation,
while inflation and inflationary expectations remain well contained.
However, while welcome, the monetary easing is unlikely to have a
significant impact on the economy, since those areas where interest rate
cuts typically show the greatest impact – housing and cars on the
household consumption side and investments on the business side – have
either continued to grow throughout the recession or are constrained by a
need to contain costs. As a result, it is not surprising that the
Consensus has lowered its 2003 GDP growth forecast yet again a notch since
last month to the current 2.7%.
Note: The above text is an abridged version of the LatinFocus
Consensus Forecast briefing for Latin America. For more details
please click
here.
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