Global recovery depends on US rebound

A recovery in the US economy is a key ingredient in the prevailing view that there will be an upturn in the global economy in the second half of 2003.

Speaking at last week’s ECB press conference, the President, Wim Duisenberg, stated that over time the euro economy should benefit from a global recovery. However, it is unlikely that the eurozone itself will contribute much to this global upturn, at least in the course of 2003. Growth is strong in Asia, excluding Japan, where the latter continues to be prone to major setbacks. It is to the US, therefore, that we must look for the main source of sustainable global recovery.

Latest data show that the US economy grew at an annualised rate of 1.4% in the final quarter of 2002. This equated to 2.9% in year-on-year terms. For 2002 as a whole, the US economy grew by 2.4%. Growth rates below 3-3.5% represent below potential performance for the US economy. This has been the picture over most of the past three years. The evidence so far this year does not suggest that the economy is back on track towards its growth potential.

There is no doubt that geopolitical tensions and the stance being taken by the US in its ‘war on terror’ against terrorist groups and rogue states have taken their toll on US consumer and business confidence. Just how well the economy is performing in underlying terms is difficult to say. There is a risk in attributing too much to the current geopolitical situation and ignoring the significant adjustment required in the US economy after the bursting of the stock market bubble, the corporate spending excesses and accounting problems.

In his testimony to Congress last month, the Fed Chairman, Alan Greenspan, expressed cautious optimism about the fundamental health of the US economy. He was cautious about the need for a further fiscal stimulus in 2003. He acknowledged, however, that further support may be necessary if the economy fails to pick up when geopolitical tensions had eased. Monetary policy tools could be employed. This means lower interest rates. Another option, which is controlled by the Treasury and not by the Fed, would be to abandon the ‘strong dollar’ policy. This latter option would do little to foster a recovery in global economic growth.

The Fed’s interest rate policy setting committee (FOMC) meets again on 18 March. There is some speculation that the Fed could cut the Fed funds rate by 0.25% to 1%. The Fed is currently in neutral mode since late last year but recent economic data could force a rethink. The latest Fed ‘Beige Book’, which forms part of the official input to Fed meetings, showed that US economic conditions remained weak in the first two months of 2003.

The balance of economic data as between the risks of higher inflation, on the one hand, and the threat of weaker employment, on the other, point to the Fed moving towards an easing bias next week. This would be seen as a signal for a possible rate cut at the next FOMC meeting on 6 May. While the chances and the need for further easing are limited, the Fed, unlike the ECB, is much more alert to the downside risks to the domestic economy. Therefore, a cut of 0.25% or even 0.5% could not be ruled out.

Last week’s disappointing labour market data, in which non-farm payrolls fell by 308,000 in February and the unemployment rate rose to 5.8%, might suggest that the Fed needs to act more urgently. However, these labour market data are lagging indicators. They were also adversely affected by poor weather conditions. It is likely that the Fed would want to hold off until after any Iraq military conflict.

Apart from the employment figures, other recent economic releases have, on balance, also been unfavourable. However, on a brighter note, there is evidence that the economy is working its way through its investment overhang.

John Beggs, Chief Economist AIB Global Treasury

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