NEWS / Foreign Exchange

World: Strong growth without the U.S.?

• The OECD leading economic indicator continues to signal slower GDP growth in the industrialized countries, but the cooling signal is concentrated in the United States. Outside the OECD there is generally little evidence of cooling.
• U.S. GDP is set to disappoint again in Q1 but the labour market nevertheless remains remarkably resilient. The flip side is sticky inflation and a significant decline in productivity growth.. As a result, we have reduced our expectation of cumulative easing in 2007 to 75 basis points from 125, for a year-end fed funds rate of 4.50%.
• The performance of the Canadian domestic economy remains very impressive despite slow U.S. growth. A strong labour market, rising home prices, strong commodity prices and a significant dose of fiscal stimulus will combine to keep Canada growing faster than its southern neighbour this year. We now see the Bank of Canada standing pat through the year rather than easing 50 basis points. We still see rate cuts, but not before 2008. Our forecast for real GDP growth stays unchanged.

World: Strong growth without the U.S.?

The OECD leading economic indicator continues to signal slower GDP growth in the industrialized countries, but the cooling signal is concentrated in the United States. Leading indicators outside the U.S. have so far remained resilient, especially in emerging Asia. Will this continue for the rest of the year?

The OECD leading economic index for industrialized countries fell in February for the third consecutive month. The six-month change ??“ considered the best measure of momentum ??“ points to an overall moderation of expansion in OECD economies, with a concentration of deceleration in the U.S. (top chart). The six-month change in the U.S. LEI ??“ 36% of the composite index ??“ turned negative in February for the first time since early 2005.

Outside the OECD there is generally little evidence of cooling. As our middle chart shows, China??™s leading indicator is the most buoyant since that country joined the World Trade Organization in 2001. Signs of moderation are slight in India and Brazil. Only the Russian outlook has weakened in recent months.

The current backdrop is such that the International Monetary Fund expects the global economy to expand a robust 4.9% in 2007. Though this overall rate is identical to that predicted in its September 2006 world outlook, the IMF has made some very significant adjustments. The most remarkable was to keep its forecast for the global economy unchanged despite a significant downward revision in its U.S. forecast (from 2.9% to 2.2%). As a result (bottom chart), the IMF is predicting a novel phenomenon for a global expansion (at least in the last 37 years) ??“ a robust world economy in 2007 with less than 10% of the growth coming from the U.S. (half its normal share). While we have little doubt that such a pattern could become common in the future, the current dependence on exports of China??™s and India??™s growth leaves us skeptical of their immunity to a U.S. slowdown.

China??™s national accounts show an expansion still driven by exports. In Q1 the trade surplus ballooned to twice its year-earlier level (in both dollar amount and share of GDP). Increased exposure to international trade obviously makes China more susceptible to the ups and downs of the world economy in general and the U.S. in particular. The U.S. currently buys about a fifth of all Chinese exports, but accounts for threequarters of its trade surplus (chart). Recent data showing a further contraction of the U.S. leading economic indicator could mean that China??™s foreign trade will contribute less to its GDP growth in the months ahead.

That development, combined with further tightening in Chinese monetary conditions to rein in credit expansion and inflationary pressures, would cool Chinese GDP in the months ahead. This said, stronger-than-expected growth in emerging countries early in the year has led us to raise our 2007 global growth forecast to 4.3% from 4%.