Macro digest

It was really no surprise that the MPC decided to hold interest rates at 0.5%, and to leave the target for QE unchanged. The exact state of the economy in Q1 will only become clearer as more data becomes available, while the disappointing progress on the inflation front prescribed caution on any further policy easing for the time being. There was also the argument for letting the QE that has been done take effect before deciding whether any more might be warranted.

As it is, the new survey data and economic statistics have probably muddied the water further. All three PMI reports were a little weaker than in Q1, while the Bank of England’s Agents’ report was more optimistic. The consumer data was weaker, and the manufacturing data was stronger; while events abroad were sufficiently mixed as to urge continued caution.

The manufacturing PMI fell back towards 50 in March, with only the employment component improving on the month. The major puzzle was the sharp slump in export orders from 51.2 to 45.3. This was in direct contrast to the Agents’ report of robust export growth, including a pick-up in orders on the month. The Agents reported rising world demand and a bigger share for UK producers. Curiouser and curiouser! On a rather broader theme, they also reported some firms bringing back part of previously outsourced production due to rising costs abroad, or due to concerns about quality and reliability of supply.

The Services PMI was also lower in April, but this belied the fact that most of the components recorded a higher reading (the headline is not a composite). Again, there was an improved employment component, which some observers are taking to imply that, even if business turns down, employers do not think it will last. New business was unchanged at 53.5 on the month. Although the construction PMI, too, fell in April, it remained above its historic average.

Despite a stronger-than-expected 0.9% rise in manufacturing output in March, wider industrial production was down 0.3%, which was in line. The latter reflected a 6.4% fall in energy output due to the third warmest March on record, and a 3.8% fall in oil and gas extraction, undermined by the well-reported gas leak at one of the North Sea platforms. While these factors may be temporary, there is probably not going to be a reassessment of Q1 GDP on the basis of this data.

In a speech last week, the Bank of England Governor, Mervyn King, noted a couple of developments that were encouraging for the future well-being of the economy – the slightly more positive news from the Bank’s Agents and an improvement in the labour statistics. That should have helped household spending, especially as the Agents’ report noted some reports of an improvement in consumer trading conditions. In the event, the BRC sales report for April was disappointing, showing a 1% fall in total sales compared to a year ago.

The problem with reading too much into this is that April of 2011 saw a lot of of extra spending around the time of the royal wedding. Then record rainfall this April put a dampener on household demand on the high street. This meant that sales were down 0.5% on the month. Hopefully, the modest improvements in the labour market will continue, and should provide some support to consumer spending.

Whether it would be enough to prop up the housing market is rather more doubtful. Eleven of the 12 region’s covered in the RICS survey reported house prices falling, with a net balance of -19, a six-month low, following the expiry of the stamp duty holiday. It’s not just a north-south divide, but a London versus the rest, with 86% of London agents reporting price rises. It will take more than an extra few thousand into employment to make a meaningful impact on housing markets outside London.

The weak US payroll growth in April (115,000) was just the evidence that bears needed to conclude that the early year economic statistics had flattered to deceive. The fourth warmest winter on record had played havoc with activity levels, and unnecessary seasonal adjustments had exacerbated the false impression of rude economic health. Now we are seeing the payback.

However, let’s get some perspective on the issue. For a start, the initial estimate of the payroll figure is just that – an estimate. The numbers are subject to large revisions. The two previous months’ job growth was revised up over 50,000, which meant that the net April figure was not that far removed from prior expectations. And, as a general principle, upward revisions are usually associated with expanding economic times.

The issue about the impact of the weather is less easy to pin down. However, the two attempts to put numbers on it have concluded that the impact was relatively small. One estimated that growth in Q1 had been boosted by 0.2%, while the other thought that the cumulative impact on job growth had been of the order of around 120,000. If these estimates are anywhere near accurate, then the distortion to the statistics will have been modest.

Other indicators of the labour market have generally been positive. Initial jobless claims have resumed their downward trend, the number of job openings is at a three-year high and small businesses are again getting more positive on recruitment plans. This is undoubtedly related to sales being at a five-year high, as small businesses are also looking to increase capex. So, from a demand aspect, things are looking up. However, skill-set mismatches remain a problem. The NFIB found that around 70% of those looking to hire were finding it difficult to do so.

Despite that frictional problem, the pick-up in employment levels is increasing households’ willingness to borrow and lenders’ willingness to lend. The most recent Senior Loan Officers survey reported a sharp increase in the demand for consumer loans and an increased willingness to satisfy that demand. Indeed, it is estimated that the level of outstanding consumer credit is back close to its 2008 peak. One area of demand that is not yet back to ‘normal’ is mortgage loan demand. A disappointingly high level of applications are still failing, and this is holding back the pace of recovery in the housing market.

That certainly has not been a problem for the auto sector. Auto loans accounted for around half of the $21.4 billion surge in consumer borrowing in March, the largest monthly jump in more than a decade. That is helping to keep auto sales purring away at an annualised rate of over 14 million vehicles. Pent-up demand, greater job security and loan availability is a potent brew.

The wider manufacturing sector is equally optimistic about the economic outlook, with the headline manufacturing ISM rising to 54.8 in April. Strength was pretty broadly-based ranging across output, new orders and employment. Specifically, the jump in the export order component from 54 to 59 reflects a continued buoyancy, despite some speculation that global trade momentum was being lost.

That was also a key feature of the non-manufacturing ISM, with export orders up from 52.5 to 58. However, overall new orders were lower, though still positive. Another feature was the decline in prices paid to the lowest level since July 2009. That will be welcome news for the Fed, should it judge that the economy needs another round of assistance. As it is, both ISMs are comfortably in expansion territory, while the NFIB is at its highest level since December 2007.

The ‘growth versus austerity’ debate has intensified as more disappointing economic numbers have been released. Unemployment in the region reached its all-time high of 10.9% in March, with expectations that there will be more to come. Of course, the incidence of unemployment varies across the region with those economies having to take the major austerity measures suffering most. And that highlights the problem – the greater the cuts, the greater the difficulty in reducing the deficit.

That contradiction was highlighted with the release of the final PMI numbers for April, which showed a slump to the lowest level since June 2009. But it is not just the present level that is a concern – the new orders-inventory balance suggests that the region’s manufacturing PMI has yet to see its low point. Apart from Ireland, which is well along the austerity road, the rest of the periphery is headed south.

The problem is that this is not a binary choice; it is a matter of balance between the two. Failure to reduce high levels of public debt merely prolong the servicing and cost of the debt. The choice rather is to determine the best balance between growth and austerity, perhaps by lengthening the target period for deficit reduction. That is what appears to be happening with regard to Spain. The region’s powers-that-be seem prepared to accept that the Spanish authorities have taken significant steps to rein in their deficit, but that to do even more to ensure the target was hit could generate a negative loop. The danger here is whether the markets are prepared to be equally as lenient.

For France, ‘normal’ service was promised with the election of the first socialist president since 1988. Normal was supposed to differentiate Francois Hollande from the so-called ‘bling bling’ presidency of Nicolas Sarkozy. But it could equally have described Hollande’s spending plans – France already has one of the highest levels of public spending in Europe, at around 55% of GDP.

However, it is highly unlikely that Hollande could push through his growth-oriented plans, without a massive, and unlikely, swing towards the socialists in the coming parliamentary elections. Hollande, though, will be able to push for a stronger growth element in his dealings with his Euro-zone partners, and here he could have some success. Nevertheless, any growth element will have to be paid for, for example, though a financial transactions tax. What does seem certain is that the growth/austerity debate will go on, and on.

In its recent press conference, the ECB acknowledged the increased risks to the growth outlook, while sounding less concerned about inflationary pressures. Although leaving policy unchanged, the shift in tone suggests that a further deterioration in the outlook for growth could bring forth some further monetary accommodation.

Just how much less optimistic the ECB has become was revealed in its semi-annual economic projections, released last week. Back in November it expected GDP in the region to grow by 0.5% in 2012 - it now expects a contraction of 0.3%. And for 2013, GDP growth is now expected to come in at 1.0%, compared to 1.3% in November. As ever, there is a wide dispersion of forecasts. However, the downside should be contained to the extent that the big economies in the region keep growing, and that the global economy avoids another 2008.

The ECB expects that the two largest economies will grow in 2012, France by 0.5% and Germany by 0.7%. Certainly, the outlook for the German economy looks promising, with new factory orders up for a second month in March (+2.2%). These were driven by a strong 4.8% rise in non-euro area orders which took Q1 orders to 3.6% higher than the Q4 average. That bodes well for output prospects, and is a reflection that global growth levels are being maintained.

It is difficult, at times, to appraise the true state of the Chinese economy. The variable timing of the New Year means that it is a challenge to meaningfully seasonally adjust the data. By the time of spring, though, the prevailing trend usually shows through. The trouble is that the Chinese perma-bulls misread the signals this year, believing that the economy had soft-landed and was ready for renewed lift-off. The subsequent release of rather softer data for April has raised doubts about such a cosy outcome.

The first misread was to treat the rise in the official manufacturing PMI as signalling a pick-up in activity. The data is not seasonally-adjusted, but when it is, it looks like the PMI was relatively unchanged on the month at around 51.5. In addition, the make-up of the official measure underestimates what’s happening to the SMEs, which have been doing relatively less well. Small companies account for about 40% of industrial output, but only 10% of the official PMI.

The detail of the PMI was equally unconvincing. Output was up, but new orders were down – not a good alignment and a relatively rare conjunction. The raw material component remained below 50, suggesting that firms saw little need to stock up. And, the import component fell to 50.5, underlining that the domestic economy is far from robust. In contrast, the ‘export new orders’ series rose to 52.2 on the month.

The other misread was to take encouragement from the surge in new lending in March to over RMB 1,000 billion. Now that was a large number, but it mostly went for short-term financing needs and for local authorities to repair balance sheets. The amount that went for long-term corporate loans actually fell further on the month to just RMB 177 billion. All of this signalled a distinct lack of investment demand.

As a stop gap, the authorities have given the go-ahead to restore credit lines to some select infrastructure projects which were interrupted in Q4 2011. Specifically, these monies are to allow the completion of these projects, with no fresh projects being sanctioned.

The authorities do face a problem. Normally, they could be assured of a positive response to a significant monetary policy initiative. This was the first occasion in the 63 year history of the People’s Republic that such an easing in policy failed to spark a jump in industrial investments. That March surge in lending fell back sharply in April.

The fiscal option is likely to be used sparingly, given the still fresh memory of the cost of the last splurge. And, in any case, any unwinding of the property squeeze would be a backward step. The economy is already far too reliant on the property sector – that must be steadily reduced if the economy is to modernise and get in better balance to compete internationally at a higher level.

So, the Chinese authorities face a tough challenge in deciding on the appropriate policy response, should the present soft patch last longer than expected. Already, forecasters have been paring back their expectations for Chinese GDP growth this year.

Japan made the final move towards nuclear-free status since 1966, when the final plant was shut down for routine maintenance. The problem is that none of the plants closed for routine maintenance has since returned to active service. So, as Japan approaches the period of peak demand there will be no nuclear contribution this year. Last year, nuclear was still contributing 11% of electricity supply – this year there will be even more calls for sacrifice to conserve energy, and limit the extent of any power shortages. The authorities will be pushing for the re-opening of newer plants, and those well away from fault lines.