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Prospects Weekly: Broadening recovery in the U.S. and Japan; downside risks in Europe

Global Macroeconomics Team's picture
So far, the spread of the sovereign stress in highly indebted high-income European countries to developing countries has been limited, due to stronger fundamentals in these economies and the massive EU/IMF intervention. The longer-term implications of the crisis will depend on the credibility of consolidation efforts and the extent that market worries spreads to other EU countries. The sovereign tensions and concerns over impacts on global demand caused commodity prices to decline, in particular oil and base metals. In the U.S. and Japan the recovery is gaining a broader base, pushed forward by rising domestic demand abetted by an improving labor market. In contrast, growth in Europe remains fragile and dependent on exports. Further fiscal tightening; lower consumer and business confidence; and depressed bank lending in the Euro area (made worse by the sovereign crisis) threaten to derail the timid recovery underway there.
Contagion from EU to EM countries? The massive EU/IMF intervention is the latest attempt to stop the crisis in Greece from spreading to other highly-indebted EU countries. The impact on developing countries will depend on the degree of contagion within the whole of the EU. So far, CDS spreads in major developing countries have not reacted much. The direct trade link is concentrated in a few relatively small countries. However, weaker growth in EU countries could further delay the recovery in Central Europe, the region with strongest trade links. Beyond trade, global markets are expected to remain volatile and relatively risk averse. Moreover, as the second round of tensions that erupted this week attests, a broadening of the crisis with potential serious consequences for global growth cannot be ruled out.  
Oil and metal prices decline on Euro debt crisis. Crude oil prices (World Bank average) reached nearly $87/bbl on the first trading day of May and then plunged almost $10/bbl. Although the initial declines were sparked by the sovereign debt crisis, the decline in prices was supported by supply conditions. Oil inventories are high and rising once again, particularly in the United States. Many base metal prices dropped more-than 10% in early May due to the sovereign crisis and its potential impact of metals demand. Prior to the plunge, metals prices had risen 6 out of the previous 7 months, reflecting destocking and recovery of demand, and restocking outside China. Metals prices are up 156% from end-2008.  
Broadening recovery in the U.S. and Japan; downside risks in Europe. GDP in the U.S. grew 3.2% (saar) in the first quarter, with a sustainable expansion in domestic demand increasingly driving the recovery. Improving labor markets have supported a rotation of growth towards personal consumption and investment, while net exports contribution to growth turned negative and that of stock building eased dramatically. Consumer demand accounted for 80% of the increase in output. GDP in Japan expanded 4.9% in the quarter (saar) also supported by domestic demand. In contrast, growth in Europe registered just 0.8% (saar). The economy still seems dominated by bounce-back factors (external demand and inventories), with limited support from consumer and investment demand. Though advanced indicators point to improving prospects, fiscal tightening and uncertainty from the debt crisis are likely to weigh on growth in the second quarter.  

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