Latin America in a Global Context - Economic Briefing July 2003

Meaningful Recovery Unlikely This Year

With the first half of year behind us, it is evident that the much-hoped for recovery will not materialise this year, as all economic regions are growing below -potential. In the United States, the Federal Reserve Board has acted yet again and lowered interest rates to the lowest level since 1958. However, rising unemployment eats away at consumer confidence, which dropped following rapid rises after the end of Iraq war. In Europe, the situation remains serious despite some encouraging signs that the governments can act on much needed reforms. Even the outlook for Asia, which had hardly felt the detrimental impact of the Iraq war on consumer and business confidence, is being adjusted downward, as the region suffers amid the lung disease SARS al though the region escaped the worst case scenarios. Meanwhile, the prospects economic growth in the Latin American region are stabilising although on a disappointingly low level.

Slower U.S. growth in first quarter
Since last month, the picture emanating from economic indicators has deteriorated somewhat even though the United States economy seems to remain poised for a tentative rebound. On 26 June, the Bureau of Economic Analysis reported that gross domestic product (GDP) increased at an annual rate of 1.4% in the first quarter of 2003. The “final” reading is unchanged from the 1.4% growth reported for the fourth quarter last year but comes as a disappointment since preliminary estimates released earlier had suggested that GDP had grown 1.9%. The downward revisions to the preliminary data reflected an adjustment on the downside to inventories and an upward correction to imports, which were partly offset by an upward revision to investments in equipment and software.

Consumption could falter as higher unemployment shakes consumer confidence
Private consumption remained the main pillar of first quarter growth figure but more recent data suggest that this pillar may weaken in the immediate future. Unemployment rose from 6.1% in May to 6.4% in June. The 0.3 percentage point increase was the largest month-to-month rise since the 11 September 2001 attacks and lifted unemployment to the highest level in more than nine years. Job cuts were concentrated in the manufacturing sector, which took the brunt of this business cycle’s labour force adjustment, as factories have cut 2.6 million jobs since July 2000. However, the jobless data contained some good news as the increase in unemployment also reflects a significant increase in the number of new job-seekers. However, rising unemployment is eating away at consumer confidence. According to the University of Michigan’s June survey, consumers still expect the economy to improve but now anticipate a pace of economic growth that is too slow to reduce unemployment anytime soon. As a result, consumer confidence slipped for the first time since March this year, even though the study claims that the small loss in confidence does not indicate the start of a more substantial decline in consumer sentiment but rather a consolidation of gains after a prolonged period of uncertainty.

Federal Reserve trims interest rates yet again
The Federal Reserve Bank, which has acted aggressively ever since the economy went into a nosedive has responded yet again to the more subdued outlook and has lowered the federal funds rate for overnight loans between banks by 25 basis points to 1.0%. The cut represented the 13th rate reduction since early 2001 and took the benchmark rate to the lowest level observed since 1958. Moreover, the Fed continued to mention the remote possibility of deflation and thus retained its downward bias, indicating that the current low interest rate setting is here to stay for a while or that rates could even be cut further.