Daily Economic Briefing: March 30, 2010

Daily Economic Briefing: March 30, 2010

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March 30, 2010

• Although this week’s major focus will be the US labor market report and the global manufacturing PMI, we also are paying close attention to data from Japan. Our forecast had looked for a significant moderation in Japanese growth in 1H10, based on a loss of fiscal stimulus to consumption and public works. Recently we have been questioning this call, and signaled our intention to raise the forecast provided this week’s February activity data and March business surveys do not disappoint.

• Following today’s reports, most of the February data for Japan already are in hand. They offer a mixed picture that probably supports a bigger revision to Japanese growth in 1Q than 2Q. In particular, IP growth is showing signs of moderating. Output posted its first monthly decline (-0.9%m/m) in a year in February. Survey respondents said they plan to raise output in March, but not in April. This pattern would deliver another strong gain in IP in 1Q while leaving 2Q on a slower trajectory. We will have a better sense of momentum following the receipt of tomorrow’s business surveys. Notably, the details of the IP report hinted at a demand rotation from consumer durables to capex, which already is assumed in the forecast. It also appears that inventory has turned the corner, which would suggest that the strongest production gains are behind us.

• Two indicators of Japanese consumer spending are tracking in very different directions this quarter, with retail sales (out yesterday) very buoyant vs a sharp pullback in the survey of household spending (out today). This situation underscores the value of the Cabinet Office’s consumption index, which typically is released in the week following these data. As of January, the Cabinet Office index, which is designed to mimic consumption in the GDP accounts, already was tracking over 6% annualized vs the 4Q09 average. One factor that is supporting consumption is the improving labor market. Today’s labor force survey showed that employment is trending modestly higher, along with the job offers ratio.

• In the US, the Conference Board’s measure of consumer confidence recovered about six of the ten points lost in February’s unexpected slide. The January Case-Shiller house price index continued to recover in January, rising 0.3%m/m. Since bottoming in May of last year, the index is up about 4%, and is down only 0.7% from a year ago.

Deflation already has arrived in some Euro area countries

Euro area core inflation fell to just 0.8%oya in February, down nearly 2%pts from the peak registered in mid-2008. The February rate was the lowest level in series history dating back to 1991. Disinflation is widespread across the Euro area, as to be expected following such a deep recession. The decline has been particularly sharp in some of the troubled economies that are so much in the news these days, including Greece, Ireland, Portugal and Spain. Indeed, core inflation has fallen below zero in Ireland and Portugal, with Spain just one step behind.

This regional pattern aligns fairly well with OECD estimates of output gaps in these countries. The OECD estimates that Germany’s output gap was 3.5% of GDP in 2009; by comparison, output gaps were considerably larger in the other countries under discussion, with the highest being just over 7% in Ireland. Near-term, the downward pressure on core inflation in all these countries is likely to remain substantial. The Euro area recovery is off to a slow start, so the output gap has not closed much even in relatively better off countries such as Germany and France. The situation is more dire in Spain, Ireland and Greece, which are likely to remain in recession this year as they enact major fiscal tightening.

To the extent that the rate of inflation in these countries falls below that of Germany, this may restore some of the competitiveness they lost in the years since monetary union (the other, more typical way out of this bind is to devalue the currency). As we showed in the March 17 DEB, for all the countries under discussion, the growth of unit labor cost exceeded Germany’s by a significant margin over the past decade. This likely explains why inflation remained higher in these countries compared to Germany, as well.

ENDS

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