Improved U.S. Consumer Demand Lifts Outlook for the Region
Even as the U.S. is recovering from stagnant growth during the initial months of the year, most other economies in the Americas region are struggling with slow growth. Prices of oil and other commodities have dipped again after a short recovery, restricting the ability of governments to increase spending. Many countries in the region depend on revenues from exports of energy and other commodities for financing a substantial part of their budgets. At the same time, central banks are cautious about potential inflation risks from higher import costs as the currencies of many countries in the region have weakened. Accordingly, they have not lowered interest rates as much as expected to boost domestic demand. Canada, where the central bank has cut interest rates this year, is an exception as inflation remains within comfortable limits. On the other hand, the central bank in Brazil has been forced to hike rates to control inflation even while the economy is in recession.
Signs of improved consumer demand in the U.S. are likely to lift the outlook for some countries in the region, especially Canada, Mexico and Colombia. Demand for manufactured goods in the U.S. could rise further in the coming months, and the weaker currencies of Mexico and Canada should help exporters even more. This should help strengthen the labor markets in these countries, and eventually lift consumer spending. For countries such as Brazil, the recovery could take longer as global commodity demand is not expected to recover appreciably in the near future. Brazil’s economy is also restrained by high structural costs and political uncertainties.
At a Glance
United States: Economic activity is now showing signs of a rebound from the weak start to the year. Consumer sentiment remains healthy, though the indices are at lower levels when compared to the second half of last year. The unemployment rate fell to 5.3 percent in June, close to the 5 percent that some Federal Reserve officials consider as full employment. The healthier economic trends have increased the likelihood of a rate hike by the Federal Reserve in September.
Canada: The Canadian economy likely declined during the second quarter of this year as lower oil prices continue to limit exports and investments. To prevent further decline in economic activity, the Bank of Canada has lowered its benchmark rate twice so far this year to a record low of 0.5 percent.
Brazil: The Brazilian economy remains in a recession, but the Brazilian central bank has continued to push up its benchmark interest rates as inflation remains a major concern. The weak economic growth is also forcing the government to abandon its budget targets, as revenue collection has fallen short.
Mexico: Lower oil prices could limit construction activity and government spending, restricting Mexico’s growth outlook for the current year. Though the economy expanded at a healthy 2.5 percent during the first quarter, the central bank has lowered its growth forecast to between 2 percent and 3 percent. Exports of manufactured goods, especially automobiles and parts, remain one of the bright spots for the Mexican economy.
Chile: After the better than expected 2.4 percent annualized growth during the first three months of this year, the Chilean economy likely slowed during the second quarter. Chile’s central bank has left its benchmark rate unchanged this year, despite the slower economic growth data.
Peru: A decline in mining investments and lower exports led to a sharp fall in first quarter GDP growth for Peru and the outlook for the rest of the year remains subdued. To revive the economy, the Peruvian government has proposed a $7 billion fiscal stimulus package that will include additional financing for infrastructure projects and revive construction of new homes.
Colombia: Among the Latin American countries, the fall in oil prices has hurt Colombia the most. However, despite the slowdown, Colombia continues to grow faster than most of its neighbors. The economy expanded 2.8 percent annualized during the first quarter, and the central bank expects growth for the full year to be around 3 percent.
Argentina: The economy expanded at a moderate pace during the first quarter of this year, as increased government spending helped offset the fall in exports. The government has been trying to prevent further economic weakness before the presidential elections scheduled later this year.
UNITED STATES: ECONOMY RECOVERING WELL FROM WEAK START TO THE YEAR
U.S. economic activity is now showing signs of a rebound from the weak start to the year. Output growth during the first three months of the year was healthier than earlier estimates, as the revised data showed a marginal expansion during the period. Consumer spending was higher than the initial reading while the narrow trade gap also boosted the economy. Though June retail sales declined unexpectedly, the trend is likely to improve in subsequent months as fuel costs have turned lower and wage growth is picking up. Consumer sentiment remains healthy, though the indices are at lower levels when compared to the second half of last year.
The labor market continues to tighten as the unemployment rate fell to 5.3 percent in June, close to the 5 percent that some Federal Reserve officials consider as full employment. Job gains during June were the most for any month this year, and the pace is likely to continue during the second half. Wages increased at an annual pace of about 2 percent during the second quarter, and should help consumer spending in the coming months. Corporate earnings growth for the second quarter exceeded expectations, and could encourage more hiring and investments in the near future.
Recent data suggests that the U.S. housing market is strengthening and, if the trend continues, could lift construction activity. Average home prices continued to rise during the second quarter while existing home sales rose to an eight year high. Home builders have become more confident about future housing demand, and have stepped up construction activity. Though mortgage rates have increased from the beginning of this year, higher rents and rising incomes are encouraging more home buyers. However, the rapid appreciation in prices in select cities has made homes unaffordable to average buyers.
The healthier economic trends have increased the likelihood of a rate hike by the Federal Reserve in September. While the Fed continues to keep its options open, further labor market gains in the coming months could encourage the central bank to announce the first rate increase after the 2008 financial crisis. However, as the Fed continues to see risks to economic growth, further rate hikes are likely to be modest and spread over longer periods.
CANADA: ECONOMY DECLINED DURING THE FIRST HALF AS EXPORTS CONTINUE TO DIP
The Canadian economy likely declined during the second quarter of this year as lower oil prices continue to limit exports and investments. The country’s GDP contracted 0.6 percent during the first quarter as mining, manufacturing and construction activity was lower when compared to the same period of last year. As oil prices have slipped again after the short recovery during the first half of the second quarter, the outlook for the Canadian economy remains subdued. Capital investments in the energy and other mining sectors are expected to be lower by 40 percent this year. Exports have declined consistently for the first five months of this year, despite the currency decline, and the trade deficit has widened.
To prevent further decline in economic activity, the Bank of Canada has lowered its benchmark rate twice so far this year to a record low of 0.5 percent. The central bank believes inflation is likely to trend lower and does not expect it to exceed 2 percent until the first half of 2017. The bank currently expects the economy to expand 1.1 percent this year, helped by a recovery during the second half, and by 2.3 percent in 2016.
Domestic demand is likely to drive the Canadian economy during the second half of this year, as consumer sentiment, though lower than last year, remains relatively healthy. Retail sales increased more than expected in May, helped by higher automobile sales, suggesting that lower borrowing costs are encouraging consumers to buy durables. Mortgage rates at record lows are also expected to support housing demand in the coming quarters. However, further weakness in the labor markets could weaken consumer sentiment.
BRAZIL: LIMITED POLICY OPTIONS AVAILABLE TO FIGHT RECESSION
The Brazilian economy remains in a recession and is expected to contract by more than 1.25 percent, according to economists surveyed by the country’s central bank. Though the decline in output during the first quarter was less than expected, as currency weakness fueled export gains, the trend is unlikely to continue in the coming quarters. Domestic demand remains weak, as retail sales dropped more than expected in May. Consumer sentiment is likely to be restrained by rising unemployment, which rose to a five year high in June.
Despite the weak economic conditions, the Brazilian central bank has continued to push up its benchmark interest rates as inflation remains a major concern. The sharp currency decline since last year has accentuated inflation pressures, severely limiting the central bank’s policy flexibility. Even with the economy in recession, inflation is running above the central bank’s target. Current borrowing costs in Brazil are at the highest level in recent years, as the central bank tries to achieve its stated goal of bringing down inflation from above 9 percent currently. the near future.
The weak economic growth is also forcing the government to abandon its budget targets, as revenue collection has fallen short. The government’s primary budget deficit, which excludes interest payments, has worsened this year. In response, the government has decided to freeze more than $2.5 billion in public spending this year, which could further limit economic activity. However, without such curbs on fiscal spending, Brazil also faces the risk of a credit rating downgrade.
MEXICO: LOWER GOVERNMENT SPENDING TO RESTRICT AGGREGATE GROWTH
Lower oil prices could limit construction activity and government spending, restricting Mexico’s growth outlook for the current year. Though the Mexican economy expanded at a healthy 2.5 percent during the first quarter, the country’s central bank has lowered its growth forecast to between 2 percent and 3 percent. The government has announced reduced public spending this year as well as in 2016. The fall in oil prices and the more subdued growth outlook has also dragged the Mexican peso lower, forcing the central bank to initiate an aggressive currency intervention program that is expected to last through September.
Exports of manufactured goods, especially automobiles and parts, remain one of the bright spots for the Mexican economy. Cars and other vehicles now account for nearly a fourth of all exports from the country with 70 percent of automobile shipments are destined for the U.S. Encouraged by the robust U.S. car market in recent years, global automakers have invested nearly $20 billion in new manufacturing and assembling facilities in Mexico. Domestic demand for cars has also accelerated this year, growing by over 25 percent after the restriction on the import of used cars from the U.S.
For the first time in several decades, Mexico is auctioning energy exploration rights to private businesses. This is part of the current Mexican government’s efforts to reform the country’s energy industry and attract more investments. Mexico’s oil output and exports have steadily declined for many years as the government-controlled company that now has a monopoly over exploration and production has been unable to make the necessary investments. The government expects investments in excess of $60 billion after the auctions, which are projected to lift output by 500,000 barrels a day over the next three years. Nevertheless, interest in Mexico’s energy assets from large global companies is likely to be dampened by lower oil prices.
CHILE: FISCAL AND MONETARY POLICIES UNCHANGED DESPITE SLOWDOWN
After the better than expected 2.4 percent annualized growth during the first three months of this year, the Chilean economy likely slowed during the second quarter. A composite economic indicators index, used by the country’s central bank to track GDP growth, showed lower readings in April and May as consumer and business confidence waned. Weaker than expected unemployment data and slower wage growth appear to have restricted consumer spending during the first two months of the quarter, before retail sales rebounded in June. Manufacturing output gained in April and June, though the month of May saw an unexpected dip.
Chile’s central bank has left its benchmark rate unchanged this year, despite the slower economic growth data. The government now expects the fiscal deficit to widen this year as revenues decline and the government spends more to boost domestic demand. This could increase inflation risks, and restrict the central bank’s ability to cut rates during the second half of this year. The government expects the economy to expand 2.5 percent this year, while the central bank lowered its forecast to between 2.25 percent and 3.25 percent.
The Chilean government is not keen to expand its fiscal spending to lift growth, as it does not view such measures as a long-term solution. The government has increased spending since last year, and prevented the growth rate from falling further. However, the major reason for the economic slowdown is the fall in prices of copper and other metals that has also substantially lowered capital investments in the mining sector.
PERU: GOVERNMENT TO ROLL OUT $7 BILLION STIMULUS TO REVIVE ECONOMY
A decline in mining investments and lower exports led to a sharp fall in first quarter GDP growth for Peru and the outlook for the rest of the year remains subdued. Despite a recovery in recent months, prices of most metals, Peru’s major exports, are below last year’s levels. Exports of agricultural produce have been stagnant so far this year, relative to the first half of 2014. Lower commodity prices have also forced producers to delay capital investments to expand capacity.
To revive the economy, the Peruvian government has proposed a $7 billion fiscal stimulus package that will include additional financing for infrastructure projects and revive construction of new homes. The proposal also includes measures to make the government more efficient and remove administrative delays for businesses. The country’s parliament has approved the proposals, which the government believes will generate an additional 100,000 jobs.
The Peruvian central bank’s policy options to revive economic growth have been restricted by higher than expected inflation. Consumer inflation remains above the central bank’s upper target of 3 percent and the bank has left its benchmark rate unchanged in recent months. Currency weakness is adding to inflation risks by pushing up the costs of imported goods, but the bank expects inflation to moderate by next year.
COLOMBIA: LOWER OIL PRICES SLOW PACE OF ECONOMIC GROWTH
Among the Latin American countries, the fall in oil prices has hurt Colombia the most. Oil shipments are nearly half of Colombia’s aggregate exports and taxes from oil production account for a large share of the government’s total revenues. In addition to the weaker external trade account, lower oil prices also limit the government’s ability to increase spending and boost domestic demand. Colombia’s current account deficit worsened to 7 percent of GDP during the first quarter of this year, and is expected to remain elevated for the rest of the year.
Despite the slowdown, Colombia continues to grow faster than most of its neighbors. The economy expanded 2.8 percent annualized during the first quarter, and the central bank expects growth for the full year to be around 3 percent. Manufacturing and mining output declined during the first three months of the year, though healthy domestic demand continued to boost sectors such as retail.
The Colombian peso has been one of the worst performing currencies globally over the last one year, losing more than 25 percent against the U.S. Dollar. Both the government and the central bank are confident that the cheaper currency will make exports from the country more competitive, and help aggregate growth this year. This has also encouraged the central bank to keep its benchmark rate unchanged so far in 2015.
ARGENTINA: HIGHER GOVERNMENT SPENDING HELPS ECONOMY
The Argentinean economy expanded at a moderate pace during the first quarter of this year, as increased government spending helped offset the fall in exports. The government has been trying to prevent further economic weakness before the presidential elections scheduled later this year. The 1.1 percent annualized pace of growth during the first three months of 2015 showed an improvement from the last quarter of 2014 when the economy expanded 0.3 percent.
The fall in prices of farm produce such as soybeans and corn have hurt exports from Argentina in recent months. The ongoing recession in Brazil, Argentina’s largest trading partner, has also restricted exports. On the other hand, lower oil prices are beneficial as Argentina is a net importer of energy.
To sustain higher public spending, the Argentinean government has increased its borrowing substantially since last year. The government’s primary budget deficit has widened appreciably since last year, though total government debt relative to GDP remain low. However, if revenues don’t keep pace with rising spending, the larger deficits could further erode investor confidence.
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