Production Recovery: The U.K. Lags Its Peers
January 20, 2010
by
Debates abound regarding the shape of the global economic recovery. Economists are quickly coming up with new symbols to describe the path they believe recovery will take; V, U, √, L, and W are all being tossed about. The conclusion from last week’s article on trade was that German exports are making the strongest showing of industrialized countries.
Along with trade, industrial production is a measure I closely follow to survey the health of various national the economies. In this measure, too, Germany stands out but this shouldn’t be surprising given the tight link between German factory output and trade. The real story is the lack of recovery for the United Kingdom.
Industrial production in the United Kingdom remains flat. After monstrous declines in Japan and Germany, the two countries saw the industrial low point in February and April of last year respectively. Since then Japanese production has rebounded 27% and German production near 10%. The United States rebounded saw its bottom later in June but has rebounded more than 4%. The United Kingdom was the last of these four countries to bottom out (in August) but has only seen a little more than a percent and a half of recovery.
With the latest November data, the U.K. is three months into its recovery. A similar number of months into their recoveries, all three peer countries were seeing a jump off the bottoms that were twice as strong. If we were giving out letter grades, I would have to say production out of Japan and Germany get a “V”, the United States a “U” and the United Kingdom just an “L” for now.
Of course, Chinese industrial production has been increasing at a robust rate throughout the past year. However, with recent news out of China that bank lending is being reined in, it is best to reserve judgment on whether or not these increases are sustainable or to be believed.
A deeper look into the November production report for from the U.K. government reveals a pattern seen around the world: a weak consumer and reasonable demand for capital goods. Capital goods are fueling exports for Germany, Japan, and the United States also. The strongest U.K. production sector was mining which includes oil and gas production.
Ironically, the sector with the biggest monthly decline was “Electricity, Gas and Water Supply” which continues to set new lows. This a familiar pattern throughout industrialized nations. Thanks to recovering prices, natural resources are being taken out of the ground at a healthy pace but the consumption of those resources are hitting new lows. The common explanation for this is that “emerging markets” led by China are devouring these resources at a brisk pace. Unfortunately, data from these countries is opaque at best. An alternative explanation is that these extracted resources are piling up around the globe.
So what does this mean for inflation? To this we are often supposed to look to the bond market. At this point in the business cycle the yield curve should be forecasting the strength of the recovery and the propensity for inflation. All other things being equal, these two things should be one in the same. The yield curves may be sending a different message though.
Yields may be beginning to reflect sovereign debt risks more than inflation. As PIMCO’s Bill Gross put it in his most recent investment outlook, yields may be a reflection of debt risk more than expectations of interest rates. When it comes to Germany, the U.S. and the U.K., this explanation is pretty plausible. In the last month, yield curves have shifted in a way supportive of that theory.
Interest rates have been moving higher in America (increased an average of 7 basis points or 0.07% across the curve above) but flat (no average increase across the curve) in Germany. Gross contends this reflects Germany’s greater ability to service its national debt in future years.
The interest rates for Japan confound this theory but the trend in the yen yield curve of the last month has been closer to that of the U.S. than of Germany. The Japanese yield curve shifted an average 8 basis points higher in the last month while the U.K. moved almost twice that (15 basis points). If the current trends continue Gross might be on to something. We need to watch the developments over the coming months.
For now, the only discernable trend for now is that recovery has taken hold most strongly in the producers of capital goods (Germany and Japan) and most weakly in the United Kingdom. Only time will tell whether than will translate into increased risk in government debt.
Disclosure: No Positions
