Chief Economist's Weekly Brief – 5 May 2009

Recession as usual

The possibility of a global flu pandemic has been added to an already long list of concerns for the global economy. It is the world's developing economies that are likely to suffer most acutely if the outbreak becomes truly widespread. However, it testifies to the more upbeat mood that the news of the outbreak did not derail markets any further.

Housing market data were in broad agreement for a change. The Nationwide house price index showed a 0.4% drop in April, after a small rise in March, matching the monthly decline from the Land Registry index (which measures actual sale prices for England and Wales). The number of loans approved for house purchase rose again in March, this time by 4% on the month, to reach 39K, providing further succour to the (admittedly thin) ranks of housing market optimists. Re-mortgaging approvals also rose (slightly) for the first time since October.

High street lenders are stepping in to fill the gap left by the withdrawal of foreign lenders. Bank of England data shows that an additional £3.2bn was made available for mortgage lending during the first quarter of 2009. This was despite a net withdrawal of £7.8bn of funds by non-resident lenders. The gap was filled by £11bn of new lending by the main UK high street banks. Nonetheless, there are few reasons to expect house prices to rebound any time soon. Prices are still above their long run average relative to earnings, demand is weak, and household debt to income levels remain one of the highest in the world.

The US recession continued to deepen in Q1. The economy shrank by 6.1% q/q (annualised) in the first three months of the year, much more than the 4.7% expected by analysts. Consumer spending was stronger than anticipated, rising at a 2.2% annualized clip, a stunning turnaround from the 4% drops seen in Q3 and Q4. Practically everything else was weaker, with particularly big drops in business investment. Inventories fell rapidly, accounting for almost half the fall in economic output. Government spending also fell, due to a decline in defence spending. Stock markets around the world took the numbers in their stride, reasoning that a cut back in inventories would lead to an increase in production in subsequent quarters. We’ll have to wait and see.

Investors were also encouraged by signs of life in the US household sector: the Conference Board’s consumer confidence index jumped by more than 12 points in April, recovering to levels last seen in October. There were fewer reasons for cheer from the auto sector. The bankruptcy of Chrysler, whilst a serious blow to US industry, does not mean the end of the road for the company. Chapter 11 bankruptcy will allow it to restructure more easily and agree new terms with its various stakeholders. The company could emerge from bankruptcy in a matter of weeks. GM has until the end of the month to agree a restructuring deal before it too could face bankruptcy proceedings.

The recession trundles on in the Eurozone. As the rate of growth of money continues to slow, lending to companies and households in the region declined for the second month in March. Lower borrowing often goes hand in hand with lower consumer spending and business investment – this time is no exception: the data points to weak growth figures for the first quarter. Deflation also remains a risk, with consumer price inflation unchanged at just 0.6% in April. These metrics will all be on the agenda when the ECB meets this week. It is expected to follow other central banks and embark on a quantitative easing programme (“printing money”) whilst lowering its headline interest rate another 25bps to 1.0%.

A rise in consumer and business confidence in the euro area in April came as a pleasant surprise. It was the first upward movement in eleven months. The jump in the index of activity in the retail sector was also encouraging. Unfortunately, rising unemployment will stop any meaningful recovery in sales and confidence. Across the Eurozone, 420K people lost their jobs in March to bring the unemployment rate to 8.9%, the highest since November 2005. The headline rate disguises underlying variation: male unemployment is rising at twice the pace of female unemployment; and the jobless rate in Spain is almost twice the regional average.

The inventory cycle lies behind a bounce in Japanese industrial production. Although demand for goods and services has fallen sharply, firms have cut back their production levels even more drastically – overall output has declined to levels last seen in the early 1980s. This meant a very sharp decline in inventories. But with stock levels now so lean, production is starting to stabilise. Output was up 1.6% m/m in April - the first meaningful increase since May last year, (though it remains 30% below its peak).

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