Latin America in a Global Context - Economic Briefing July 2004

Optimism Seizes Virtually All Economic Regions

The global economy remains poised for robust growth this year, following on two years of anaemic growth.  Moreover, the prospects for next year are also positive.  While all regions are recovering, the upturn is most pronounced in emerging Asia, particularly China, and the United States but also increasingly Japan.  However, the United States economy is burdened with sizeable deficits in the current account and public sector balances, which could trigger a sudden adjustment in the foreign exchanging markets and threaten future growth potential.  The Japanese economy seems to be in for a strong rebound, following on several sluggish years.  However, fundamental misalignments in the financial sector persist and the country remains burdened with deflation.  As a result, the momentum of this year’s recovery is seen to wane in the coming year.  The outlook for the major European economies, on the other hand, remains sombre.  The Euro Area will recover from last year’s slump but economic growth remains moderate.  Finally, Latin America is in for a robust recovery, as all economies are profiting from increased external demand.

Increasing optimism for Japan lifts outlook for global economy
The outlook for the global economy continues to improve.  Compared to last month, the average forecast for global output growth this year inched up another 0.1 percentage point to 4.3%, the fourth consecutive increase and a full percentage point above the growth projected in September last year.  Not surprisingly – and in line with the trend observed in the past months – this month’s upward revision was not prompted by increased optimism for the United States.  On the contrary, the Consensus sees the U.S. economy  growing a notch slower than last month.  Japan is the key driver behind the upward revision to the global growth outlook.  Sentiment for the Japanese economy continues to improve, as current developments imply a much quicker expansion than anticipated earlier.  Consensus Forecast panellists have lifted their outlook for Japanese GDP growth by 0.6 percentage points over last month to the current 4.2%.  Owing to the rapidly improving projections for Japan and an unchanged outlook for the U.S. economy, the growth difference for 2004 between Japan and the United States has shrivelled to just 0.3 percentage points, down from more than two percentage points anticipated at the beginning of the year.   Next to the substantial upgrade for the Japanese economy, the Consensus Forecast has also lifted the projection for ex-Japan Asia, Europe and Latin America.  The Euro Area is seen a notch more optimistically, following on a slight upward revision to the growth outlook last month.  In particular, Germany, whose lagging economy had marred the outlook for the entire region, seems to be benefiting from increased global demand more than anticipated earlier.  That said, growth in the Euro Area will remain moderate at 1.8%.  Finally, Latin America is also expected to grow a notch faster than expected last month, as upward revisions to Argentina, Mexico and Venezuela lifted the regional economic growth forecast to 4.2%.

U.S. first quarter growth lower than expected
According to revised estimates released by the Bureau of Economic Analysis on 25 June, gross domestic product (GDP) expanded at an annual rate of 3.9% in the first quarter of 2004, following on 4.1% growth in the fourth quarter last year.  The actual reading was well below expectations, which had economic growth in line with the preliminary estimate of 4.4%.  The slight deceleration in GDP growth compared to the fourth quarter primarily reflected a slowdown in exports and investment in equipment and software.  These decelerating effects were partly offset by a pickup in government spending and private consumption, supported by a deceleration in imports. 

Fed raises interest rates for first time in over four years
On 30 June, U.S. monetary authorities raised interest rates for the first time in more than four years.  Following a unanimous vote, the Federal Open Market Committee (FOMC) decided to increase its target for the federal funds rate by 25 basis points to 1.25%.  The decision had been widely expected, given the sharp rise in inflation in the first half of the year and numerous announcements by Federal Reserve officials that had prepared the ground for higher rates.  Similarly, just as expected, the FOMC statement maintained a neutral risk assessment, claiming that “upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters are roughly equal”.  The FOMC reiterated that it would raise interest rates “at a pace that is likely to be measured” and added a somewhat more affirmative tone by claiming that authorities “will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability”. 

Economy might have hit a soft spot
While the interest rate hike did not come as a surprise, it marks an important turning point, as removes it the cushion provided to the economy by record-low interest rates and most likely introduces a long tightening cycle.  The timing of the FOMC decision to tighten is crucial, as a premature interest rate hike could threaten to derail the economic rebound that hinges on cheap credit for households, businesses and investors.  The most recent data suggest that the U.S. economy might have hit a soft spot.  In June, payrolls grew by only 112,000 jobs, well below the 235,000 gain recorded in May and well below market expectations of 250,000 new jobs.  The data raise concerns that the jobless recovery that had characterised the rebound until late last year could again resurface.  In March and April this year, these fears were quelled by strong employment data.  In May, however, the surge in new jobs began to ebb and the job report even worsened in June.  In addition, the Labor Department revised the strong March and April data downward.  Additional indicators also point downwards: durable goods orders dropped in May for the second consecutive month, June vehicles sales plunged to a six-year low and anecdotal evidence suggests that June retail sales were also weak.