NIBC: Mixed signals about economic activity

The Chart of the Week shows real exports and government expenditures in Japan. After eurozone inflation fell to 0.4% in July and eurozone GDP growth stagnated in Q2, financial market participants strongly urge the ECB to engage in quantitative easing. The purchase of assets should help to raise inflation and support economic growth. Where is the ECB waiting for? Start the money ‘printing’ machines and create economic growth! If it was only that simple…

Global

Have geopolitical developments already started to bite into Western economic activity? Ongoing geopolitical tensions and fights in several parts of the world will obviously not have a positive effect. Nevertheless, we are inclined to think that mixed signals about economic activity have so far not mainly caused by geopolitical developments. The economic picture in most countries remains a slow or at best modest one.

Japanese GDP plummeted by 6.8% (qoq annualised) in Q2 after +6.1% in Q1. The jump and subsequent plunge in economic activity was of course a reflection of the contraction in domestic demand following the hike in the sales tax in April. But the underlying GDP data showed more weakness than meets the eye at first sight. The build-up of inventories added 4% to annualised GDP ‘growth’ in Q2, real wage growth was -1.8% on a quarterly basis and the 5.0% quarterly drop in private consumption was larger than after the sales-tax hike of 1997.

One of the problems with creating inflation via a depreciation of the yen is that Japan is highly dependent on energy and food imports. As a consequence, the devalued yen may improve export opportunities for corporates, but it also raises costs for households and companies and therefore weakens domestic demand. The third quarter will be extremely important for Abe.

Staying in Asia, the People’s Bank of China reported that aggregate financing growth (a broad measure of liquidity) plunged the most since at least 2002 on a monthly basis. The PBoC (which normally doesn’t publish separate statements on data releases) said immediately after the data that the weakness was amongst others caused by seasonal factors. The PBoC’s statement showed that sentiment about China has clearly changed the past quarters. An increasing number of people are concerned about the extremely rapid build-up of debt the past years and the sustainability of economic growth. Indeed, recent central bank monetary stimulus programmes may have helped to support credit growth again somewhat. And from that perspective, China has fast become hardly any different from most Western nations: it has become addicted to debt.

United States

The news was somewhat mixed. The NFIB small business optimism index picked-up to 95.7 in July from 95.0 in June. the NFIB index signaled that labour market conditions improved further (see chart), more firms intend to raise compensation and fewer firms said that credit is ‘hard to get’.

A different story was told by retail sales data. Sales stagnated in July after +0.2% in June. Retail sales excluding auto, gasoline and building materials (used as input for consumer spending in the GDP report) rose by only 0.1%. Consequently, the three-month annualised rate slowed from 8.1% in April to 2.7% last month. Overall, we remain confident with our projections for close to 3% annualised GDP growth in the third and fourth quarter. This week’s macroeconomic agenda will focus on consumer price (CPI) data, the FOMC minutes and the Fed’s Jackson Hole symposium.

Eurozone

Even before geopolitical risks fully materialised, euro area second quarter GDP reports showed that economic activity stagnated. By country, the German economy contracted 0.2% (after +0.7%) and the French economy stagnated for a second consecutive quarter. One of the consequences was that France said that it will no longer meet its 3.8% budget deficit target.

The latest reports dashed hopes further that the eurozone economy might even expand by an already slow 1% (as was expected by the Bloomberg consensus) this year. 1% seems already too high at the moment. If geopolitical events had a large effect in Q2, the direct and indirect negative impact on GDP growth should be even larger in Q3 as tensions have intensified rather than eased the past two months. ‘Unfortunately’ for the ECB, interest rates are already at record lows, not only government bond yields, but also for example overnight borrowing costs (Eonia) declined further after the ECB meeting in June (see chart). After all, it makes hardly any sense for the ECB to provide economic support via the credit channel (by lowering interest rates) in a low interest rate environment.

The ECB will probably move slowly towards a QE programme. But the central banks that engaged in QE the past years proved that such programmes could create wealth effects (i.e. inflation) in certain asset prices (bond markets are not necessarily the main beneficiaries), but that the economic effects were uncertain.

United Kingdom

The labour market report was a mixed bag that showed the first drop in earnings since 2009 as average weekly earnings fell 0.2% (3m/yoy) in June. On the other hand, unemployment is with 6.4% at its lowest since Q4 2008. Last week’s Inflation Report showed that policymakers are focussing on the labour market and especially on wage developments. As wage growth is weak and unit labour costs modest, the BoE can still afford to wait a little longer before tightening policies.

Accordingly, forward looking interest rate derivatives show that financial markets are no longer pricing in a rate cut for 2014 after these two reports. We remain confident with our expectations of the first rate hike to be in Q2 2015 with smaller chances for Q1.