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Global recovery at challenging stage
October 2010
Global recovery is challenging
New Zealand’s recovery is modest
Global recovery is challenging
By AXA Global Investors Chief Economist Bevan Graham
The global economic recovery is in its most challenging stage. The inventory cycle, which involved
countries and businesses rebuilding stock levels depleted during global financial crisis, has ended and
the momentum being provided to growth from global government fiscal stimulus is waning. In more
normal recoveries, stronger consumer demand would be kicking in by now to fill the gap. This transition
was always going to be one of the most challenging aspects of this recovery.
We are now finding the true strength of underlying final consumer demand and in some countries it is
weak. We have written before about how challenging this economic recovery was going to be, that it
would be non-linear in nature (i.e. it would hit some rough patches along the way) and that deleveraging
(.e.g. paying off debt) at the household and then government level would keep developed economy
growth subdued for a long time.
Indeed, the recovery in the United States economy is slowing and we expect it to do no better than
muddle through over the next few months. The euro-zone is best described as patchy with growth in
Germany at record levels reflecting the weak euro and strong export growth. At the other end of the
spectrum, Greece is suffering under the weight of fiscal austerity and is still contracting.
Growth in emerging markets continues to be strong. India and Brazil in particular are at risk of
overheating. In those two countries, the biggest challenge for policy makers is to take appropriate action
to combat inflation.
In China, growth has slowed but that’s a good thing. In our view, growth in China is slowing to a more
sustainable level. We are more relaxed now about the need for authorities to take further action to
combat inflation. Indeed house prices have come off the boil over the last quarter, reducing concerns of a
bubble in that market.
There is still a significant imbalance between global capacity to grow and total demand, although for us,
the gap isn’t as big as some think it is. Given the structural nature of the recession (a structural recession
occurs when a deep, underlying problem in an economy can no longer be denied), we believe a lot of
spare capacity in the global economy is better described as redundant capacity. Automotive capacity in
Detroit is a good example.
Nevertheless, the supply-demand imbalance has renewed fears of deflation, especially as growth has
slowed in China and the United States. We continue to see little risk of a bout of deflation in the global
economy. There is (just) sufficient demand to avoid that outcome, especially with inflation emerging as a
problem in some economies, albeit the emerging markets.
However, a deflationary liquidity trap cannot be ruled out for every country. We see little risk of deflation
(a decline in general price levels, often caused by a reduction in the supply of money or credit) in the
United States, although disinflation (disinflation is a decrease in the rate of inflation – a slowdown in the
rate of increase of the general price level of goods and services in a nation's gross domestic product over
time) will still be the order of the day until the recovery gathers momentum again in 2011. We cannot be
so confident about parts of Europe.
There is still a lot of work to be done to address global imbalances. Consumption growth is strong in
China, but more needs to be done to better distribute the benefits of growth so that consumption can
continue to grow.
In this regard we are still looking closely at developments at the various G20 forums to discern the future
shape of the global financial system and, more generally, the future shape of the global economy.
We are about to go through a thorough testing of the current economic orthodoxy, with a broader range
of countries (the G20) involved in the discussion than previously (the G7). We don’t for a minute believe
socialism is at risk of winning the debate, but there are various shades of capitalism. The model that just
died is the completely unfettered unregulated model of US capitalism. Another better, stronger version
will emerge in time.
New Zealand’s recovery is modest
By AXA Global Investors Chief Economist Bevan Graham
New Zealand’s modest economic recovery continues to be modest. Annual growth in the year to March
stood at 1.9%. The traditional drivers of growth remain subdued and are expected to remain so as
households focus on debt repayment and remain cautious about their largest asset, their houses.
The labour market remains soft, although volatile data makes interpretation challenging. Over the last
three quarters, we have had unemployment readings of 7.1%, 6.0% and 6.8%. The 6.0% in the March
quarter was the outlier, while the drop form 7.1% in December 2009 to 6.8% in June 2010 is more
indicative of the modest nature of the recovery.
As with many developed countries, we believe the pathway to lower unemployment will be challenging.
New jobs will require a different skill set than the jobs that have been lost, meaning we will likely see
higher unemployment than we have recently been used to and where skills shortages emerge at the same
time.
Exports are growing well and the improving terms of trade will underpin growth in the period ahead.
Given our more than usual dependence on exports this cycle, we are looking for a strong capital
expenditure cycle to be the next key ingredient to a stronger New Zealand recovery.
The inflation picture will be somewhat blurred over the next few months as the impact of the Emission
Trading Scheme and the increase in GST impact the headline CPI inflation numbers. The Reserve Bank will
look through the initial impact of these factors, but will be keeping a sharp eye on underlying inflation
pressures.
We have been advocates of a continued gradual tightening in monetary policy in New Zealand, reflecting
the extreme stimulatory nature of monetary settings, even after two 25bp tightenings in the Official Cash
Rate to 3%.
Even recent weak data didn’t change our view, but the devastating earthquake in Christchurch has.
Indeed the Reserve Bank has put the tightenings on ice for a while with no move in interest rates in
September.
While the earthquake will have a negative impact on growth in the short term, the significant amount of
reconstruction of homes, buildings and public infrastructure will be positive for economic growth over
the next 12-18 months.
This will absorb significant spare capacity, particularly in the construction sector. However, this will not
be a shift to a permanently higher level of capacity utilisation that, in itself, requires action from the
central bank. Furthermore, the reconstruction will simply take productive capacity and the housing stock
back to where it was before the earthquake.
Nevertheless, the Reserve Bank will not be able to delay further tightenings in monetary policy for long.
Monetary settings are still exceptionally stimulatory. Failure to keep in front of inevitable inflation
pressures would raise the possibility of the Reserve Bank making the same mistake they made last cycle –
letting domestic inflation get away on them. If that happens, we would then see more aggressive
tightenings further down the track than would otherwise be required.
Given the nature of the recovery, we believe there is a real opportunity to cement in a lower interest rate
cycle this time around, but that is by no means a certainty.
Meanwhile, across the Tasman, the Australian economy is going from strength to strength. The 1.2%
increase in GDP over the June quarter was better than market expectations and took the annual rate of
growth to 3.3%.
The strong impact of China on exports growth and the price effect through the booming terms of trade are
all well known. The surprise in the data was that consumption showed signs of life. Job growth is also
strong with the unemployment rate down to 5.1%. Australia remains one of the strongest performing
economies in the developed world, but the extent to which this success is externally driven by China just
reinforces the importance of key emerging markets to global growth over the next few years.
Core inflation in Australia is probably running higher than the Reserve Bank of Australia would like and
we expect them to resume the tightening in interest rates later this year.
We retain the view that Australia will continue to outperform New Zealand over the next couple of years,
at least in terms of broad activity indicators. We expect New Zealand GDP growth of 2.5% this calendar
year and 3.0% next year, compared with 3.5% for both periods in Australia.
Your feedback is welcome
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