USA
Incoming data in the U.S. continues to be mixed, but on the whole it seems to be suggesting a better outlook. Although consumption has been stronger than expected, manufacturing production has been extraordinarily weak. All in all, manufacturing production has fallen at an 18.7 percent annualized pace over the past three months, while goods consumption has been roughly stable.
The wide gap between output and spending has been a reliable signal of massive inventory contraction in the past, and this is also the message from other economic data; analysts expect $100 billion in inventory liquidation in the first quarter of the year, and $120 billion in the second quarter. As a percent of GDP, this would be the largest quarterly drop in inventories on record. How long can this pace of inventory liquidation go on? History suggests not very long.
According to the observable six decades of quarterly GDP data, this type of inventory liquidation usually has persisted for only one quarter, and never for more than two quarters. There is little reason to think that the inventory dynamics should be much different than is usually seen during deep recessions, and the pace of liquidation should be easing modestly in the third quarter of this year. If this scenario comes true, overall GDP growth is to move back into positive territory. As the change in inventories is the one that matters for GDP growth, a lesser inventory drop means the contribution to GDP is positive.
Europe
Economic slack in the eurozone has been accumulating rapidly, as is particularly evident in the labor market and in capacity utilization. The unemployment rate hit 8.5 percent in February; during the past six months, it has risen a full point. Recent data suggests it may increase 0.2 percentage points in March: the uptrend remains significant. Capacity utilization in January was 75 percent, which is the weakest reading since 1975. What's more, the de facto degree of economic slack may be rather greater than these numbers suggest, on account of improved economic efficiency.
More flexible labor market practices brought about by deregulation have lowered the non-accelerating wage rate of unemployment, which is why some analysts project that eurozone unemployment may rise to a post-war high of 11 percent, implying a greater degree of economic slack being generated. Moreover, manufacturers, helped by investments in technology, have found ways to run plants even more efficiently, suggesting the non-accelerating price rate of capacity utilization may have risen. It is also worthwhile to pay attention to Sweden's terrifying economic data.
The latest activity indicators suggest that the first quarter real GDP is likely to have fallen by more than even the 2.4 percent quarter on quarter drop recorded in the fourth quarter of last year. As a result, GDP may contract this year by at least 4.5 percent 's far below the 1.4 percent decline factored by Sweden's Central Bank. Having by now posted four consecutive quarters of negative real GDP growth (in every quarter of 2008), output is already 4.4 percent below the peak reached in the fourth quarter of 2007, and by the middle of this year is likely to be at least 7.5 percent lower than at that peak.
Baltic Region
Poland's request this week for the IMF's new Flexible Credit Line (FCL) opens a new chapter regarding the IMF's role in the region. Poland is the first country to take up the IMF's new offer of "stigma-free, no conditions attached" money, which is particularly aimed at the stronger economies that would otherwise shun IMF support. Thus, rather than playing the role of a crisis fighter (as in Iceland, Ukraine, Latvia, Hungary, etc.), in Poland the IMF is becoming a mere FX liquidity provider 's not dissimilar, for example, from the support the ECB could otherwise provide through FX swaps.
The motivation for Poland seems clear: The $20 billion FCL raises its available FX reserves by about one third, which should help to calm PLN volatility and thereby support the case for ERM II entry. The spring meeting will also offer a platform to discuss developments in other IMF supported countries in the region. This week's news reports from Latvia signals rising difficulties with the IMF program implementation, with the Finance Minister publicly discussing the risk of missing the IMF-EU disbursements scheduled for June. Ultimately, this again may raise the question of the viability of the region's pegged exchange rate regimes, which in addition to Latvia, would affect Estonia, Lithuania and Bulgaria.
*** Written using materials from Bloomberg, Reuters, and Barclays Capital Economics Research
