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Prospects Weekly: European Stability Mechanism (ESM)/Fiscal Pact laws remove significant hurdles

Global Macroeconomics Team's picture
The ratification of the European Stability Mechanism (ESM)/Fiscal Pact laws by the German Constitutional Court removes significant hurdles from deeper European integration and was positively received by markets, with borrowing costs declining sharply for Spain and Italy. And today the Federal Reserve announced a third round of quantitative easing to boost growth and reduce unemployment, including open-ended purchases of $40 billion of mortgage debt a month and continuation of other assets purchases till labor market conditions improve. Industrial production (IP) shows signs of stabilization in July but performance in Q3 is expected to remain lackluster as business sentiment indicators remain depressed. Meanwhile, maize and wheat stocks are expected to decline in 2012/13 due to adverse weather conditions, with the maize market likely to be very tight.
While key developments in Euro-area since last week suggest the risk of an acute crisis has subsided, uncertainties remain. On September 12th, Germany's Constitutional Court ratified the €700 billion ESM that is crucial to resolve the region’s ongoing debt crisis and is a key requirement for the European Central Bank’s (ECB) new bond-buying program announced last week. However the court has ruled that increases in potential German liabilities above €190 billion will be subject to parliamentary approval. In September borrowing costs have declined sharply for Italy and Spain, with 10-year sovereign bond yields at 5.02% and 5.62%, respectively. This is particularly important for Spain, which has to repay more than €20 billion in debt by the end of October. The ECB, EC and the IMF decision on the aid program for Greece is expected in early October.


Industrial activity appears to have bottomed out in July, but August business sentiment surveys and inventory dynamics point to a weak performance in Q3. Newly released data suggest that IP growth may have bottomed out in July. Notably Euro Area IP surprised on the upside in July, up 0.6% m/m, with a positive outturn in Germany as both domestic and export orders rose. China’s IP growth also improved, expanding at a 5% annualized pace in the three months to July up from a dismal 2.8% pace in Q2. High global inventory levels and weak final demand suggest that inventory adjustments could be a drag on growth in Q3, especially in the Euro Area and China. Inventory dynamics are more favorable for growth in the G3 and the East Asian tech exporters. In China high inventory levels will weigh on growth in coming months, but front-loading of spending on infrastructure should support growth going forward.


The US Department of Agriculture kept its 2012/13 global grain outlook largely unchanged in its September 12 update; yet, there are upside price risks, especially for maize. The assessment was widely expected with marginal effects on futures. For maize, the 2012/13 stocks are expected to be 12.2% lower than the last season (and 18.6% below the May 12 assessment). This brings the stock-to-use ratio down to 14.4%, the lowest level since 1972/73 and 2.6 percentage points lower than in 2007/08. With stocks that low, even a small supply shock could trigger a large price spike while high oil prices could make maize-based ethanol an attractive alternative. Although wheat stocks are expected to decline by 11% from the last season, the wheat market is better supplied with stock-to-use ratio of 21.9%, 5 percentage points higher than in 2007/08. Despite weather problems earlier in the year and the on-going Thai rice purchase program, the rice market seems to be well-supplied, with prices relatively stable.


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