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Prospects Weekly: Global industrial production activity has nearly stalled

Global Macroeconomics Team's picture

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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