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EU Monetary Stimulus 2011 - Economics Weekly

Global Economics Weekly Brief

The EU and UK EU Monetary Stimulus of 2011

The Governor of the Bank of England is hoping that increasing monetary stimulus will help steer the economy into calmer waters.
By injecting more funds into the UK economy, and quickly, Mr King aims to counteract some of the drags on growth coming from weaker global activity and worries about banking and sovereign debt conditions in the Eurozone. Meanwhile, his European Central Bank (ECB) counterpart, Jean Claude Trichet, also took action to increase liquidity in the Eurozone banking system in an attempt to promote some stability. But overall, there is little prospect of a strong recovery. Choppy times lie ahead. Also, more QE will be needed in the future to steer economies away from very choppy waters globally!

QE2 arrives in the UK.
After 22 months of no change to rates or the size of the asset purchase scheme, the Monetary Policy Committee (MPC) surprised the markets by expanding quantitative easing (QE) by a larger than expected £75bn, to £275bn, at its October meeting. MPC sentiment had been moving towards extending QE recently, indeed it was identified as the preferred monetary policy option in the last set of minutes. But the bold move, coming ahead of the Bank’s new forecasts and decisions on plans for supporting the Eurozone at the G20 meeting in November, has raised some eyebrows. More QE will be needed in the future!

UK growth has slowed to a crawl. The downward revision of UK GDP from 0.2%q/q to just 0.1%q/q in Q2, was disappointing, but even more so was the news that the economy had contracted by 7.1% in the recession rather than the 6.4% previously estimated. The Q2 story was one of weakness in consumer spending and net exports, offset by government spending and business investment, leaving the economy fairly flat. But with government spending scheduled to go into reverse around the turn of the year, this may have been the news that tipped the balance for the MPC. Manufacturing in deep decline, very few first time buyers for houses and retail in the high street in further retreat with more businesses `going-bust!

Rebound in UK manufacturing and services to prove short lived? The Purchasing Managers’ Index (PMI) for services rebounded from 51.1 in August to a more reassuring 52.9 in September. The improvement was driven by new business growth, but a decline in expectations to a 30-month low highlights the uncertain outlook. The manufacturing equivalent jumped from 49.4 to 51.1 (a reading below 50 indicates contraction), chiefly driven by a run down in backlogs of orders. Taking the shine off this figure was the steepest contraction in new export orders since May 2009, as global growth slows.

Eurozone interest rates stay put, but the banking system gets more liquidity. At his final press conference, ECB President Jean-Claude Trichet’s parting gifts were a €40bn covered bond purchase program (starting in November), two new one-year refinancing operations for banks, and a promise to keep shorter term facilities in place until mid 2012. These initiatives will come as welcome news to the Eurozone financial system following the bailout of the Franco-Belgian bank, Dexia. In terms of conventional monetary policy, the ECB left interest rates at 1.5% at its October meeting. European banks are in deep trouble!

Surveys indicate that the Eurozone is slowing rapidly. The Eurozone composite PMI for manufacturing and services declined from 50.7 in August to 49.1 in September. This is the first time the index has dropped below 50 since July 2009. Manufacturing PMI dipped to 48.5 in September while services came in at 48.8, with new orders for both sectors the weakest in over two years. It is no wonder the ECB expects only “very moderate” growth in the second half of the year, with the risks tilted to the downside.

In the US, manufacturing expanded but service activity slowed in September. The Institute of Supply Management (ISM) manufacturing index increased to 51.6 last month from 50.6 in August. The acceleration in activity was driven by an increase in new orders from emerging economies, but demand at home remains clearly subdued. Moreover, the backlog of orders among US manufacturers hit a 32-month low, adding to worries that production will slow. The index for services edged lower to 53 in September from 53.3 in August, with the survey signalling job cuts in the sector over coming months.

Unemployment remains uncomfortably very high in the US. Non-farm payroll numbers revealed that 103k new jobs were created in the US economy over September, while August's dismal jobs figure of zero was revised up to 57k. But the improvement in hiring was not enough to bring the overall unemployment rate down from 9.1%, where it has been stuck since July. A rise in private sector employment of 137k in September was offset by a 34k decline in the public sector workforce. While it is welcome news that the US jobs machine is still ticking over, it still has a lot of work ahead of itself - the average monthly increase of 72k since April is less than half of the average 161k for the seven months prior to April. House prices are still falling and unemployment still on the rise!

Interest and Exchange Rate Forecast

Same song, different moves. With the economic outlook looking decidedly shaky and Europe's debt crisis still unresolved, the same song is ringing in the ears of central bankers. But their reactions have been distinctly different. The US made the first move as Federal Reserve Chairman Ben Bernanke did the twist – selling short dated bonds and buying long-dated bonds in an effort to lower long term interest rates, thereby helping to stimulate investment and output (short-term fix!). This was followed by a surprise move by the Bank of England Governor Mervyn King who opted for a second round of quantitative easing. At his last meeting as President of the European Central Bank, Jean-Claude Trichet focused on non-standard liquidity measures. The recent bias towards policy easing, on top of already very accommodative monetary policy, provides a clear picture of how precarious the current economic environment is. All this has been supportive for the dollar despite distinctly lacklustre fundamentals in the US, underlining the perception that this currency is viewed as a safe haven in times of high uncertainty.

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EU Monetary Stimulus 2011!

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Comments on this item:

clyde huchet
17-10-2011 17:49:07
More encouraging news. All we can do is keep our head down and moving forward (hopefully) inch by inch.
03-05-2017 07:30:54

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