Globalization & Monetary Policy Institute
International Economic Update
Uneven Global Growth Suggests Fragile Recovery
May 6, 2013 · Update in PDF
Uneven growth across countries is contributing to a fragile recovery, with some short-term risks easing and the focus shifting toward medium-term risks. With the euro-area crisis remaining a pressing risk to the global economy, developments in the region are closely watched. Interest has also shifted to Japan, where a new round of quantitative easing has begun.
Global Economic Activity Soft Patch
The world economy is expected to grow at a moderate 3.3 percent rate in 2013, revised down from the January forecast of 3.5 percent from the International Monetary Fund (IMF). The outlook for 2014, however, appears more solid, with global growth accelerating to 4 percent. Emerging economies continue to bolster world growth as advanced economies lag behind (Chart 1).
Other indicators of economic activity are mixed and suggest unbalanced growth for 2013. The March global composite Purchasing Managers Index (PMI), which includes manufacturing and services, increased slightly to 53.1 from 52.9 in February, while the global manufacturing PMI decreased to 50.5 in April from 51.2 in March. The global softening in manufacturing indicated by the PMI numbers seems to have reached the U.S. and major emerging economies such as China, which are inching even closer to the expansion–contraction level of 50. China’s economy slowed to 7.7 percent growth in first quarter 2013. China’s official manufacturing PMI fell modestly to 50.6 in April from 50.9 in March. Manufacturing PMI numbers also declined in Brazil, Russia and India. The Institute for Supply Management’s manufacturing index in the U.S. dropped to 50.7 in April, from 51.3 in March, erasing almost all of the gains of the PMI in the first quarter. However, the U.S. still posted real GDP growth of 2.5 percent.
Global Inflation Holds Steady
Global inflation pressures remain restrained due to continued slack in advanced economies and subdued commodity price developments. In the U.S., global inflation patterns contributed little to overall price increases, with March import prices decreasing 2.7 percent year over year and declining 0.2 percent excluding oil (Chart 2).
In the U.K., the Bank of England is expected to continue to surpass its 2 percent inflation target over the next two years, while in the euro area, the European Central Bank (ECB) is forecasted to keep inflation under 2 percent. On May 2, the ECB decided to cut policy rates by 0.25 percentage points to 0.5 percent in order to facilitate the flow of credit and economic growth. In turn, the Bank of Japan (BoJ) is aiming for a similar target of 2 percent in an effort to boost prices. Japan’s headline inflation is expected to turn positive in 2013 due to the BoJ’s recently enacted “quantitative and qualitative monetary easing” (Chart 3).
The marked shift in the BoJ’s monetary policy stance announced on April 4 involves almost doubling the monetary base and the balance sheet by the end of 2014. The BoJ also plans to increase purchases of government bonds and extend the average maturity of its government bond holdings from about three years to roughly seven years. Another change to the BoJ portfolio consists of an increase in purchases of exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs). The easing will continue until the new 2 percent target is consistently achieved. The announcement of the deflation-fighting strategy had an immediate reaction in the markets, sending the Nikkei 225 stock market index climbing 4 percent and the yen down 2.7 percent against the dollar. The exchange rate was 99.4 yen per dollar on May 6 (Chart 4).
Financial market reactions are consistent with higher inflation expectations, but if rejuvenated growth does not accompany increased inflation, policymakers could face difficulties addressing already-large fiscal deficits. The 10-year break-even inflation rate has increased since the announcement, standing at 1.9 percent on May 2 (Chart 5).
Policy rates in Russia and China remain unchanged. However, the Reserve Bank of India cut its policy rate by 0.25 percentage points to 7.25 percent on May 3, while Brazil’s central bank increased its benchmark rate, the Selic rate, by 0.25 percentage points to 7.5 percent on April 17. Increases in headline inflation and growing inflation expectations prompted the Central Bank of Brazil to end almost two years of monetary easing, amid a tight labor market despite slow growth.
Developments in the Euro Area
While developments in Cyprus have been closely monitored by global markets, the bailout of the Cypriot banks in March appears to have had a limited impact in the euro area. Sovereign bond yields in Spain and Italy were largely unaffected, despite prolonged negotiations to resolve the Cyprus bailout and the status of depositors.
Spanish and Italian bonds are now at their lowest levels in over two years, reflecting a mix of developments that have spurred a rally in peripheral euro-area debt. The reelection of Italian President Giorgio Napolitano on April 20 prompted a drop in bond yields in Italy and Spain. After last summer’s high bond yields and another period of elevated yields after Italy’s inconclusive elections in February, Italy’s 10-year bond yield dropped to 3.8 percent and Spain’s fell to 4.0 percent (Chart 6). Enrico Letta, Napolitano’s choice of prime minister, gained the approval of parliament and has since formed a broad-based coalition government with the aim of tackling urgent economic reforms. In spite of the decline in sovereign yields and their positive contribution to improving the fiscal situation of these economies, the euro area is still seeing poor economic growth.
Spain’s unemployment rate grew to a historic high of 27.2 percent in first quarter 2013, leaving over 6 million people unemployed. The country remains mired in recession, posting its seventh straight quarter of negative economic growth. The Spanish government revised its forecast for 2013 growth down from a decline of 0.5 percent to a decrease of 1.3 percent. Spain also has one of the euro area’s largest public deficits and has implemented a series of austerity measures over the past years to rein it in. To ease the effects of fiscal consolidation, the country was recently given until 2016, an additional two years, to meet the European Union deficit limit of 3 percent of GDP.
Germany is also experiencing a slowdown in growth, a possible spillover from the poor performance of the periphery. The Markit Composite PMI flash estimate, which includes manufacturing and services, fell to 48.8 in April from a final reading of 50.6 in March. This represents the first time this indicator has fallen into contractionary territory since November, as Germany and other countries in the euro-area core are contributing to a weaker pulse of real economic activity. With the euro area still the most significant risk to the global economy, the recovery is fragile.
About the Author
Grossman is a research assistant in the Globalization and Monetary Policy Institute at the Federal Reserve Bank of Dallas.