USA
There are two chief uncertainties surrounding Fed policy. Can the Fed successfully "exit" from its accommodative policy regime without causing disruptions to the economy, and when will the Fed deem such action to be appropriate? In his semi-annual monetary policy testimony, Fed Chairman Bernanke outlined the former, but was unsurprisingly vague on the latter. The Monetary Policy Report provided Bernanke with the chance to outline the Fed's exit strategy. He noted that the "passive" unwind is already underway as demand at the liquidity facilities naturally declines with an improvement in financial conditions. However, given the Fed's massive asset buying program, its balance sheet is likely to remain large.
Bernanke argued that the Fed has a number of tools to tighten, even with a large balance sheet, focusing on its ability to pay interest on reserves. The Fed can hike the interest on reserves rate in lockstep with the fed funds rate, thereby maintaining a high level of reserves but still tightening policy. The Fed could also shrink its balance sheet by selling assets, but that seems to be the last resort. Bernanke made it clear that the Fed has the tools to tighten policy, but it is not ready to do so. In particular, he stressed that the Fed will need to see a convincing economic recovery with sufficient improvement in labor market conditions and reduction of excess slack. The unemployment rate is expected to reach 10% by year-end and remain above 9% through next year, which is likely to be too high to allow the Fed to tighten. Unless the recovery proves healthier, there's little chance the Fed hikes rates anytime soon.
Euro zone
Although the majority of the 'flash' estimates for euro area Q2 GDP are not due for publication until August 13, a tantalizing appetizer is served up this Wednesday in the form of the official preliminary estimate of Belgian Q2 GDP growth. Belgian activity data rarely take center-stage 's unsurprisingly, given the economy's small weight (less than 4%) within euro area total output. However, this week's GDP estimate will be an exception by providing a useful bellwether of broader developments within the euro area (at the most basic level, a simple correlation coefficient of 0.86 between the q/q GDP growth rates in the euro area and Belgium over the past decade underscores the latter's usefulness as a gauge of growth more generally).
The estimate is that the Belgian economy contracted about 0.7% q/q in Q2, after two consecutive quarterly declines of 1.7%; that feeds into the forecast for a euro area Q2 contraction of 0.5% q/q. However, the risks to the Belgian GDP forecast appear to be skewed heavily to the upside. Given that euro area forecast is for a "strong" -0.5% q/q, any material upside news from Belgium this week could trigger a modest upwards revision to the euro area estimates. Moreover, a suite of GDP indicators for the larger euro area economies also signals that the net balance of risks to Q2 growth is tilted to the upside.
Central and Eastern Europe
Signs that the crisis in Russia has hit the floor continued to emerge in June. After some positive news from industrial production, other monthly indicators started to show some signs that the crisis has possibly bottomed out. Investment to production fell by 20.1% y/y after the worst decline of 23.1% y/y in May. Disposable income declined by 1.0% y/y in June after a 1.3% y/y contraction in May. Retails sales showed the worst 6.5% y/y decline in June (5.6% y/y contraction in May), though they have been reacting with a lag. Unemployment continued to show some signs of stabilization, declining slightly to 8.3% in June from 8.5% in May; however, there's some seasonal effect there with a pick-up in agricultural production in the summer.
Overall, it seems that H1 was the worst for Russia, suffering a 10.1% y/y decline in GDP. However, the pace of economic decline is expected to slow in H2, with support from the anti-crisis measures. In particular, Prime Minister Vladimir Putin recently signed a decree on the use of about 1.36 trillion rubles (19.4 million euros) from the Reserve Fund for the financing of the budget deficit in Q3, which should speed up implementation of the anti-crisis measures, especially in public consumption and investment.
• Written using materials from Bloomberg and Reuters Research
