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Prospects Weekly: Global industrial production activity has nearly stalled

Following fourteen months of vibrant growth, global industrial production activity has nearly stalled, reflecting the waning impetus from inventory restocking and a fall-off in growth of final goods demand earlier this year. More recent strengthening of capital goods production and retail sales volumes suggests that this is a temporary slowdown. However, if final demand disappoints, the slump could become protracted, with downside risks gaining greater weight. Movement toward additional monetary easing in high-income countries, while developing countries have begun to normalize their stances (Brazil, China, India, Thailand), has contributed to an upswing in foreign capital inflows to many developing countries. The associated pressure for currencies to appreciate has prompted a large build in reserve accumulation. Credit-default swap spreads for several high-income European countries eased in recent weeks, partly reflecting a temporary step-up in ECB purchase of affected-country bonds.
Global industrial output growth slowed to below its historical average rate in August 2010. The slowdown has been led by developing countries (excluding China), which posted a 1% contraction in the three-months ending August (3m/3m saar). Even in China, which posted third quarter GDP growth of 10 percent (saar), industrial production expanded at a modest 4.8 percent pace in the 3-months ending August 2010. Our baseline expectation is for IP growth to regain its historical trend. However, the depth and duration of the slowdown will depend significantly on final demand, the dynamics of which are mixed. Strengthening retail sales in Europe, the United States and Japan; slowly improving labor market conditions, and strong machinery and equipment sales point to firming demand. However, declining exports in Japan and Europe, and a still deteriorating housing sector in the United States point in the opposite direction.
A number of countries have sharply increased their foreign reserves in September, as they attempt to counter market forces that have been driving up local currency values. Without direct market evidence of foreign exchange intervention, reserve accumulation in the 12-months through September 2010 has been exceptionally large for several countries—up $595 billion vs. $765 billion in 2007. The pace intensified in September to almost 3 times the average rate of accumulation in 2007. China accounted for the bulk of accumulation in the last year relative to 2007 (88%), followed by Japan and Brazil (13%) and Korea (8%). This follows a period of much weaker reserve buildup after the onset of the crisis.
While investor concerns about European sovereign-debt persist, credit default swap (CDS) spreads have receded from recent highs. This partly reflects a temporary increase in purchases of peripheral Euro-Area government paper by the ECB in late-September, which contributed to the decline in credit default swap rates in Ireland and Portugal. Also, Greek bonds rallied of late on improved but still fragile confidence, most recently supported by the IMF indicating that it is ready to give the country more time to repay loans. In contrast, among riskier developing-country sovereigns (Argentina, Venezuela), CDS rates increased in the last week, though they remain significantly below recent highs posted since the onset of Greece’s crisis in May.

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Prospects Weekly: Global industrial production reaches inflection point

A slowdown in global industrial production is becoming evident, as the inventory cycle is drawing to a close, notably in the United States, and as fiscal support measures in key economies are being withdrawn. Growth in industrial output is expected to slow in high-income countries and the large developing economies, especially in China, which has been leading the business cycle. The Euro Area continues to lag other economies, with exports being the main driver of the recovery, notably for Germany. Stronger exports boosted business and consumer confidence, despite concerns about European sovereign stress.
Global industrial production (IP) growth is moderating in line with a normal recovery. Purchasing managers’ indexes (PMIs) point to moderation in the pace of IP growth in major developing countries (Brazil, Russia, China, India, and South Africa) and in core high-income economies. June manufacturing PMIs suggest a slowdown to near 7% among the BRICS in the third quarter from nearly 10% in the second, and to 3.1% in core high-income countries from 7.5%―as growth in China and the G3 countries ease. The fall below the threshold "50" mark for China’s new orders and output PMI components suggests that East Asian economies, which benefitted from strong Chinese import demand, will see moderation in coming quarters. Taiwan (China) reported a monthly decline in factory and export orders in June; and IP corrected sharply in Singapore after an impressive six-month rise.
Euro-Area confidence surveys surprise to the upside. Confidence surveys for July unveiled surprising improvement in expectations for the economic outlook, jobs, investment returns and more confidence in banking systems. Germany’s IFO business climate index unexpectedly surged to a 3-month high, up 4.4 points to 106.2; and the EM flash manufacturing PMI jumped to 61.2 as consumer confidence increased to pre-crisis levels. Core Euro zone countries are viewed to moderate to a near-trend growth pace, as the positive contribution to growth from inventories is likely to run its course by the third quarter, and bank funding stress will continue to weigh on growth. Pent-up demand for durables and the effects of monetary policy should aid growth. Germany’s IP is likely to ease to a still robust 12% pace in the third quarter down from 22% in the second (saar).
EU stress test results reveal that seven banks failed to maintain a minimum 6% Tier-1 capital ratio; €3.5bn in capital to be raised. Covering 91 European banks, the test focused on how they would cope with another economic downturn and losses on trading portfolios of government bonds. A group of five Spanish cajas (unlisted savings banks), Germany’s Hypo Real Estate, and the Agricultural Bank of Greece failed the tests. These banks would require €1.84bn, €1.25bn and €243mn respectively. In an adverse ‘sovereign stress’ scenario, the EU banking system’s average aggregate Tier-1 capital ratio would decline to 9.2% by 2011 from 11.2%, with overall impairments totaling €566bn. Some of the test assumptions were considered overly benign by analysts, but the disclosure of sovereign debt exposure is broadly seen as a positive, and spreads have narrowed by 24 basis points since the release of the results. The key test is still on the funding side, with European banks having to refinance €1.6trn by 2012.

Download the Prospects Weekly as PDF here.