Keeping an eye on monetary policy

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June 5th, 2014

The overall economic outlook is good. On the one hand, cyclical indicators for Q2 point to an increasing dynamism of economies at a global level and for the developed economies in particular. At the same time the Fed's comments regarding its monetary strategy have tended to be expansionary, showing little inclination to rush into normalisation. Moreover the ECB has made the most of hinting at implementing further stimuli in the near future. These messages from the central banks have helped to relax yields on sovereign debt in both regions. Risky assets, like equity and corporate bonds, have continued to perform well, with some indices on Wall Street and in Europe even setting new records. The incredibly low volatility of the markets is also significant. With this starting point, the immense complacency currently reigning among investors could give rise, should there be a setback, to readjustments in financial asset prices and a more volatile financial environment. This might well occur if the ECB or the Fed end up taking a less accommodative stance.

The US economy is back on an upward track after a Q1 hit harder by the adverse weather conditions than initially estimated. The balance of the extensive battery of indicators published in May comes out on the positive side. Most of the business sentiment and consumer confidence indices are optimistic. The labour market is also continuing to improve although some aspects still need to be taken into consideration. In April, employment figures provided another pleasant surprise but were marred by a further drop in the participation rate. Given this gradual but still incomplete recovery, the Fed has decided to remove the numerical target of 6.5% for the unemployment rate from its monetary forward guidance. Nonetheless, it is important to keep a close eye on signs of a possible change in trend, such as business surveys on expectations of wage rises in the near future, which have already been hinted at.

Conditions have also embarked on a favourable trend in the emerging countries, albeit not uniformly. The environment is less uncertain now that the turbulence experienced at the beginning of the year has started to get back to normal. The governments and central banks in many of these countries have handled this setback well and are being rewarded by investors returning part of the capital that had left their economies at the start of the crisis. The stock markets and sovereign bonds of some of these economies, such as Indonesia, Turkey and South Africa, have performed excellently over the last few months, recovering part of the losses suffered in 2013. In China cyclical indicators point to an end to the slowdown and the government's recently implemented economic policies, such as May's liberalisation of the capital market, are helping to rekindle expectations for its economy.

The euro area's recovery is advancing at a good pace, albeit with widening gaps between countries. For the euro area as a whole, the signs of recovery seem to be long-lasting. An increasingly strong domestic demand has joined the foreign sector, with notable improvements both in private consumption and investment. The breakdown by country is less encouraging, however. One extremely positive note is Germany's surprising growth in GDP in 2014 Q1, up by 0.8% compared with the previous quarter. At the other end of the scale are France and Italy, once again posting worse figures than expected with zero growth for the French and continuing contraction for the Italians
(–0.1% quarter-on-quarter). Such results are fuelling doubts regarding the growth capacity of both countries in the medium term and scepticism concerning the structural reforms implemented. The other weak chain in Europe's macroeconomic situation is still inflation. That is why all eyes are on the ECB and especially on how it will handle the expectations that it has been encouraging over the last few months.

In Spain, domestic demand has started to grow with the breakdown of GDP for 2014 Q1 revealing notable improvement. Private consumption and investment in capital goods performed particularly well and continue to advance strongly while exports came as a disappointment, falling by 0.4% in quarter-on-quarter terms. Part of this slowdown is due to temporary factors and we still believe that the trade surplus achieved will consolidate in the medium term, although the trend in the foreign sector will now have to be closely monitored over the coming months, as well as other factors. In order to avoid risk scenarios, and acknowledging that the reforms carried out to date have been far-reaching and beneficial for the Spanish economy, the IMF still has a long and demanding list of homework for Spain. Particularly important is tax reform and the development of a framework that helps to restructure company debt.