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The State of the Business Cycle

The State of the Business Cycle. Frankfurt, 13 April 2005 Dr Holger Schmieding European Economics Bank of America, London +44 20 7174 4924. Globalisation spreading to more countries, more sectors, more workers Rise of Emerging Eurasia, from Bratislava to Bangalore and Beijing

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The State of the Business Cycle

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  1. The State of the Business Cycle Frankfurt, 13 April 2005 Dr Holger Schmieding European Economics Bank of America, London +44 20 7174 4924

  2. Globalisation spreading to more countries, more sectors, more workers Rise of Emerging Eurasia, from Bratislava to Bangalore and Beijing Shift from labour to profit income Helped by the information technology revolution, productivity growth remains high in US, despite some signs of a slowdown IT revolution strengthens consumer choice Increased pace of supply growth and reduced wage pressures constrain inflation risks The demographic challenge: Germany and Japan vs the US and France Longer-term Themes: From Worker to Consumer Power

  3. US Productivity Growth Still Strong Labour productivity in US business sector, annualized change in %. Source: BLS Remember the “new economy”? There was some kernel of truth in the notion.

  4. Erosion of Union Power Paves the Way for Reforms Source: DGB; DAG Would Hartz IV have been possible 10 years ago?

  5. US is removing its extraordinary monetary and fiscal stimulus. Inflation Outlook: Globalisation and technological advances augment the pace of supply growth, the erosion of union power reduces the risks of wage inflation, increased consumer choice enhances competitive pressures. Inflation risks now look more subdued than in the last 3 decades. US outlook: Sound fundamentals. We expect only a slight growth deceleration in 2005 as consumers gradually raise their savings rate in response to more normal interest rates. Worries about the US twin deficits are overdone. Eurozone: A modest pick-up in domestic demand will be largely offset by a reduced external stimulus in 2005. Growth below trend until late 2005. Japan: Structural progress, but Japan’s upswing is too vulnerable to bear a slowdown in Chinese demand and a strong Yen at the same time. BoJ rates on hold until mid-2006. Oil: The renewed surge in oil prices will hit global growth in Q2 and Q3, in the Eurozone slightly more so than in the more flexible US. Expect a modest fall in oil prices later in 2005. Asset bubbles? Cyclical Themes: US Healthy - Europe Vulnerable

  6. US Corporate Health Restored Share of pre-tax profits in US nominal GDP. Source: BEA US corporate profits have recovered back to normal.

  7. US Households Are Rich – Not Overindebted Source: Fed US households are more heavily indebted than before. However, they are also more wealthy. Real wealth adjusted for debt is back on trend.

  8. US Consumers: Excessive Debt Burden? In % of disposable income. Source: Fed; BEA In line with lower nominal interest rates, interest income has fallen. Many households would benefit from higher interest rates.

  9. US Consumer: Help from the Labour Market Yoy change in %. Source: BLS Although higher interest rates will be a burden for some households, extra income from an improving labour market should offset this even for lower-income groups who are not major recipients of interest income.

  10. Fiscal Deficits – Signs of Improvement in US Yoy change of 12-month rolling sum, in %. Source: US Treasury; BEA The US fiscal balance has started to improve, helped by a rebound in tax revenues. Tax cuts are over. Capital gains tax receipts are recovering. We expect US tax revenues to rise by at least 6% per year.

  11. House Prices: Spot the Bubble Average earnings for UK; average weekly earnings for US; rebased to 1974-2003 average = 1. Source: ONS; ODPM; BLS; Bloomberg The UK has a serious house price problem – the US does not. In a fast-growth economy such as the US, real estate prices should rise in real terms over time. In the UK, supply constraints add to the volatility of house prices.

  12. Japan: The China Factor Yoy change in Japanese exports to China, 3-month average. Source: MoF Japanese export growth has started to falter. A slowdown in Chinese demand for investment goods will likely dampen Japanese GDP growth to around 1% in 2005.

  13. The big external stimulus already faded last summer Leading indicators have turned down again Investment: Only a modest upturn likely Consumption: Higher oil prices restrain growth in disposable income Technical rebound in Q1 GDP likely to be followed by weaker Q2; expect some strengthening back to trend growth in late 2005 if oil prices and the euro decline. Huge disparities within the Eurozone Real estate boom in “Club Med”: Liquidity-driven bubble - or sustainable adjustment to EMU-related permanent decline in interest rates? Eurozone Outlook

  14. Eurozone Leading Indicators Turning South Again Source: EU Commission survey Industrial confidence has fallen sharply, the halting rebound in consumer confidence has stalled.

  15. Eurozone Export Outlook: Mediocre at Best Yoy changes in %; Bank of America forecasts for trading partner growth from 1Q05 onwards. Source: Eurostat; BoA The rate of demand growth among trading partners and the lagged impact of exchange rate changes drive Eurozone exports. A deceleration of global demand has started to reduce export growth.

  16. Eurozone Domestic Demand: Investment Outlook Yoy change in %, gross fixed capital formation and gross operating surplus including mixed income. Source: Eurostat Buoyant profits support investment.

  17. Eurozone Consumption: A German Problem Consumption levels, 1Q95=100. Source: Eurostat The weakness in German consumption is weighing on the Eurozone as a whole.

  18. Regaining cost competitiveness within the Eurozone thanks to wage restraint Hoping for the lagged impact of recent labour market reforms Leading indicators have turned down again Significant decline in household savings rate unlikely No support from the housing market Decline in working age population and continuing transfers to East Germany will make further benefit cuts inevitable German Outlook

  19. The Demographic Burden Source: OECD; OECD forecasts for 2004-05 Is Germany reforming fast enough to cope with the demographic challenge?

  20. The Demise of Wage Inflation? Total hourly labour costs in whole economy, advanced by one year; service CPI and service CPI excluding German health care charges on right-hand scale; yoy in %. Source: Eurostat Wage inflation has fallen sharply in the Eurozone, following years of weak domestic demand. We look for headline inflation to drop below the ECB’s 2% pain threshold again in June.

  21. Eurozone Inflation: Oil Matters Direct and indirect impact of oil prices on headline inflation. Source: Eurostat; BoA forecasts from April 2005 onwards We expect oil prices to moderate to €35 per barrel Brent crude by end-2005. Near-term, oil prices pose the greatest risk to our inflation forecast.

  22. Global Economic Forecasts

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