US on track for a 'soft landing'

greenspun.com : LUSENET : Grassroots Information Coordination Center (GICC) : One Thread

Tue, Sep 5, 2000

US on track for a 'soft landing'US on track for a 'soft landing' Prospects for other regions are problematic

Michael Hartnett

The 107 interest rate increases the world economy experienced in the past year have paved the way for an economic cool-down over the next few quarters. Some regions of the world are likely to experience a gentle easing in growth, while others could be in for a bumpier ride.

The US economy, for instance, is likely to have a "soft landing", where growth will continue-albeit at slightly weaker levels-and inflation remains relatively benign.

But other areas, such as Europe, are more problematic. The European Central Bank (ECB) faces a dilemma: rising inflation pressures and a weak currency would argue for higher interest rates. On the other hand, the prospect of economic downturn may necessitate steady or lower interest rates.

Meanwhile, Japan, which recently saw its first monetary tightening in 10 years, is expected to see further slight increases in money market rates, which are likely to keep the yen underpinned short-term.

In the US, there are few reasons to believe that the scenario of steady growth and moderate inflation is at risk. The main threat to this rosy picture is the oil price, which has remained much higher than most analysts expected at the start of the year.

Global demand for oil is strong, while Opec, the organisation of oil-producing countries, has failed to boost oil production enough to cause prices to fall. Our oil experts are forecasting an increase in production quotas to be agreed at the September 10 Opec meeting. If so, oil prices should settle in a $25-to-$30 range.

American consumers are expected to spend about $50 billion more on oil products in 2000 than they did in 1999. This extra expenditure reduces gross domestic product by about half a percentage point.

But even if oil prices stabilise at current levels, there should be no further negative impact on growth or inflation. If they fall into the range we are forecasting, it would reduce headline inflation slightly and boost GDP minimally.

Europe's outlook is murkier. Economic growth seems to be peaking-as witnessed by the sharp downturn in the German IFO business sentiment survey, which confounded expectations by taking another dive south to 99.1 in July from 100.4 a month earlier.

And yet, headline inflation in Euroland continues to come in consistently above expectations. Oil-fed inflation has stubbornly planted itself above the ECB's target range at 2.4%. The euro is trading uncomfortably below 90 US cents, and money market rates are inching higher, with the marginal money market rate trading about a quarter of a point above the ECB's official repo rate.

A rate increase by the ECB in response to rising inflation, however, could be a mistake. For if such a move pushes up the value of the euro, this will probably cause overall monetary policy to be much tighter, increasing the burden on the domestic economy later in 2001. The ECB might come under pressure to reverse its last rate increase.

Although headline inflation has breached the upper limit of the ECB's target range, underlying inflation remains remarkably well-behaved. We expect core inflation to rise moderately over the coming 12 months, from 1.3% presently to a peak close to 1.8% next July. But by that time, headline inflation should have fallen to about 1.2% due to the strong base effect of current high oil prices.

Meanwhile, we believe that Japan would be best off with a continued easy monetary policy and a neutral or slightly restrictive fiscal policy.

However, the Bank of Japan (BoJ) is clearly thinking along different lines. The BoJ appears to be fairly optimistic on the strength of the economic recovery, and therefore appears poised to tighten monetary policy further.

With central bank governor Hayami calling interest rate policy "extremely easy" now, added rate increases toward a "neutral" stance will likely follow, if the Bank of Japan's optimistic view on the business cycle materialises. We think it probably will.

While it is uncertain what a "neutral" policy rate would be, it is clear that the current 0.25% call rate limits policy flexibility. It is so close to zero that it restricts the BoJ's ability to ease policy effectively. To regain full flexibility, a call rate target of 1% seems reasonable-allowing room to cut rates as a counter to an unforeseen "shock".

Right now, economic data are key. If the Tankan business sentiment reports due on Oct 3 and Dec 13 show a further broadening of the recovery-from large to small companies and from industry to services-a Dec 15 rate increase becomes more likely.

- Michael Hartnett is senior international economist with Merrill Lynch in New York.

http://www.bangkokpost.net/today/050900_Business07.html



-- Martin Thompson (mthom1927@aol.com), September 05, 2000


Moderation questions? read the FAQ