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Prospects Weekly: Economic activity in high-income countries, yields on safe-haven contracting, developing country growth

Global Macroeconomics Team's picture

Economic activity in high-income countries weakened in Q4 2012, with output in a number of large economies contracting. However, January business sentiment data points to a pickup in activity. With increased expectations of a strengthening global recovery, and receding downside risks, yields on safe-haven assets have risen in recent months as investors rebalance their portfolios towards higher yielding assets. In the face of a modest strengthening of developing country growth and with many developing countries operating close to full capacity, continued trends toward monetary easing risk increasing current dormant inflationary pressures.

High-income countries’ GDP growth in Q4 2012 weakened, but recent business sentiment data suggests an uptick in activity. For the first time since 2009, US GDP contracted in Q4 2012 (-0.1% saar). However, the details provide a more nuanced picture. On the positive side private consumption and fixed investment expanded rapidly, in sync with improved conditions in labor, housing and retail markets. On the downside were a sharp decline in defense spending and a fall in inventories – partly payback for the inventory buildup in Q3 and also reflecting drawdowns due to hurricane Sandy and uncertainty in the run-up to the November elections and the “fiscal cliff”. Prospects for Q1 are mixed. Business sentiment is improving (January PMI reached a 22-month high), labor market conditions are strengthening and capital goods orders have risen further. However, increases in payroll taxes will cut into incomes and consumer demand in Q1. Similar trends in high-income Europe are reported, with Q4 GDP declines in the UK, Spain, Poland, and Belgium. January Euro Area PMI data suggests a significant easing of the down turn there.

Reflecting declining risk perception, yields on safe-haven assets are rising as portfolios are rebalanced towards higher-yielding assets. With growing optimism over a strengthening global economy and receding downside risks, yields on safe-haven assets (German Bunds and US Treasuries) have risen in recent months. Yields on the benchmark 10-year US Treasury bonds, after reaching a record low of 1.38% in July 2012, climbed past the 2% mark during intra-day trading on January 28 - the first time in 9 months. Improved market confidence is likely to translate into increased capital flows to higher yielding emerging-market corporate and sovereign bonds.

Despite growing signs of a modest acceleration in global activity, central banks in many developing countries have further eased monetary policy in early 2013. Average annual inflation rates for both high-income and developing countries declined about a percentage point in 2012, partly reflecting economic weakness and earlier policy tightening. However, in 2012, monetary policy in developing countries eased, with the number of policy rate cuts four times the number of policy hikes. This easing trend continued in January, with seven developing-country central banks (Albania, Angola, Bangladesh, Colombia, India, Mongolia and Turkey) easing further, while only one (Serbia) raised rates. While global inflationary pressures remain benign, given the lags in monetary policy transmission, this additional easing may add to a strengthening already underway resulting in additional inflation in countries operating close to full capacity, without much payoff in additional output.

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