Economy in Brief: October 2022

If there are any inflation deniers out there, it is well past time for them to 'man the lifeboats' and make an emergency evacuation from this point of view. Inflation is raging and is accelerating sharply. In Germany – once a paradise of solid price stability- inflation over 12 months is 11% rising, at a 10.6% pace over six months -barely indicating any abatement, and then jumping to a 16.2% annual rate over three months. These are not just accelerations of inflation from a depressed base. One year-ago the German HICP was up by 4.2% year-over-year. At the time, people were arguing that inflation rate was distorted. Ha! Little did they know…

Of course, Germany is not in control of its own inflation rate anymore the way it once was because it's part of the European Monetary Union and tied into this basket of countries that has different inflation tolerances and different economic and fiscal arrangements as well.

EMU is what it is... The European Monetary Union is a monstrosity formed based on an idea by Robert Mundell on something he called an 'optimum currency area (OCA).' And like many things in economics, this concept was used to justify the formation of a 'European Monetary System' even though the members of this system do not qualify as an ideal OCA based on the criteria that Professor Mundell had set forth for such a union to be successful. For one thing, in their zeal to have a common currency, Europe was never ready to pull its fiscal fortunes together. There is no overarching fiscal policy as each country runs its own fiscal house although there are rules that can be used to bring countries back to fiscal morality when they stray. The reality, however, has been that it is only in the wake of Europe having employed this rule to discipline fiscal laxity that countries were put under severe stress and pressure and the European Central Bank eventually was pressed into service to make policies that have been far more inflationary than anyone would like to sustain the union.

German inflation and recession The German domestic inflation rate is officially put at 10% and there's a new record pace of inflation since Germany has been reunified. But for those of you who remember history, we know that Germany has suffered far worse inflations than this as Germany's hatred of inflation stems back to its pre-War era of hyperinflation. The Bundesbank now looks for Germany to enter recession and it also recognizes that inflation is too high, and it urges - and expects - the ECB to be raising rates by another substantial amount at its next meeting. However, quite clearly the toothpaste is out of the tube. The Bundesbank argues that the economy will suffer a recession, but it will not be a severe recession. That's a curious argument. When we combine the notion of recession in the German economy with the ECB raising interest rates sharply, and with the energy shortages being experienced, it's hard to know why the Bundesbank would want to stick its neck out to say that the coming recession would be relatively mild. It seems that the risks are for relative severity.

Inflations in Germany is broad – not isolated or concentrated Inflation diffusion for in Germany in September shows inflation went up across about 59% of the categories; this is a sharp acceleration from August where it went up in only 31.8% of the categories; in July it went up in only 9.1% of the categories. During these three months, Brent oil prices measured in euros fell by 5.3% in September, by 6.8% in August, and by 7.3% in July. We know that oil prices don't get into the CPI index immediately, but this has been a period in which oil prices are falling. In fact, oil prices fall on balance over six months and over 12 months. Yet, the inflation statistics for Germany are ugly

The inflation diffusion across categories over three months, six months, and 12 months shows inflation extremely broad on the order of 70% to 80%. That means over those time horizons inflation (annualized) is rising in 70% to 80% of the major CPI categories. Specifically, I calculate diffusion as derived from the three-month percentage change compared to the six-month pace and then the six-month pace compared to the 12-month pace, and then 12-month pace compared to the pace over 12-months in the comparable month of one year-ago. On all those comparisons prices are broadly accelerating across CPI categories.

Core inflation accelerates Core inflation for the HICP rises from 6.3% over 12 months to a pace of 8.4% over six months to a pace of 12.6% over three months - those are all annualized rates and they're all extreme. The domestic CPI excluding energy accelerates from 6% over 12 months to 7.8% over six months to 11% over three months also showing sequential acceleration, the same message as from the HICP core.

The U.K. economy is suddenly experiencing a world of hurt. With a new government and a budget change that was not well received and then was retracted, the financial markets have been under pressure. The Bank of England has been active trying to stabilize financial markets. However, there's only so much you can do with band aids chewing gum, and a stapler.

Transition to greater weakness The economy has transitioned into a more serious state of decline. The rate of decay makes it look like it's already in recession. In August manufacturing industrial production fell by 1.6% following declines of 1% in July and 0.8% in June. Industrial production figures are adjusted for inflation, so these are real declines and the real decline in the U.K. industrial production is now 6.7% over 12 months. IP is falling at an 8.1% annual rate over six months and falling at a 13.2% annual rate over three months. These are substantial negative growth rates, and they are accelerating and there are declines across all sectors. The deceleration in growth also is across nearly all sectors, with two exceptions. Capital goods are a very minor exception because the year-over-year fall of 8.7% slows down slightly to a 7.8% rate of decline over six months before resuming at a 9.5% rate of decline over three months. Consumer durable goods also fail to show sequential deterioration but continue to show a good deal of weakness. Consumer durable goods output declines by 4.2% over 12 months, at an accelerated 6.4% annual rate of decline over six months, but then it slows to an annual rate of decline of 1.6% over three months. However, both consumer nondurable goods and intermediate goods show sequential real declines and acceleration in the rate of those declines over six months and three months, rounding out the picture of a fast-weakening manufacturing sector.

QTD growth U.K. data trends also show quarter-to-date declines and all the sectors show manufacturing output falling. Manufacturing output falls at a 10.9% annualized rate, two months into this quarter. Consumer nondurables has the sharpest decline in its QTD growth rate among sectors at -10.1%, but intermediate goods output at -9.4% is close behind, as is capital goods within a decline at an 8.5% annual rate. Consumer durables output is falling at a 4.5% annual rate, about half the pace of decline the other sectors.

Sectors ae mostly lower since Covid struck U.K. output has fallen sharply over the past year; the table documents it's down significantly over 12 months as are all the sector measures. As a result of those declines, U.K. output is now lower than it was pre-pandemic in January 2020. All sectors except for consumer nondurables show net declines as well. Consumer nondurables output is still 5% above where it was in January 2020. Overall output shows a short of its January 2020 level by 1.3%; capital goods output is the farthest behind, at 6.4 percentage points below its output level in January 2020.

Industry weakness is broad-based The bottom of the table shows trends for five key industries in the U.K. Only two of these industries fail to show sequential deterioration. One of the exceptions is textiles & leather where after falling by 5.9% year-over-year output trends fall at only a 2.6% pace over six months but then they collapse to fall at one of the stronger negative growth rates of -21.6% over three months. In the end, which makes it not much of an exception.

Not surprisingly utilities are an exception, but they still aren't very strong. Utilities output is up by 7.1% since before Covid struck. Sector output is up by 1.9% over 12 months. Growth in the sector is moderate to weak except for the 6.4% annual rate over six months. But after that, it's back to dead flat over three months. The monthly pattern for electricity, gas & water shows declines in August and July after a significant 2.7% increase in June.

Food, beverages & tobacco are up by 10.3% on that same timeline to before the point that Covid struck. But textiles & leather output is 13.1% lower, mining & quarrying is 14.4% lower and motor vehicle & trailer production is lower by 35.2%. The bottom line is since Covid only food and utilities output have expanded.

Australian business confidence in September fell to 4.8 from 9.9 in August. It was as strong as 7.6 in July. Business conditions, in contrast, improved to 24.7 in September from 21.6 in August and 21.9 in July. Forward orders increased to 14.7 in September from 13.7 in August and 11.3 in July. Despite the one-month drop in confidence, business conditions and forward orders show improvement.

Monthly changes in the components can be erratic, but the three-month averages show a decline in business confidence. Business conditions components show declines in exports and in exporters’ sales in September and modest gains for the three-month average compared to the six-month average. September data focus on foreign weakness as an impediment.

Over both three months and six months, confidence deteriorates as conditions improve. The 12-month average compared to 12-month ago shows declines in business confidence as well as business conditions.

In September, most observations are above their historic means. The exception is the reading for confidence itself; it is a tick below its mean value. Among components exports are below to their historic mean with a -1 reading slightly below the mean of -0.8 for the period back to May 2002.

Ranking statistics show a good deal of strength. The overall confidence measure has a relatively weak reading with the rank standing in its 38th percentile. This compares to a three-month standing at its 56th percentile and a 12-month average standing in its 63rd percentile. These progressions show that as we look at more recent periods the standing of the confidence index is weaker; there has been some loss of momentum in confidence.

Business conditions are mostly strong However, among components of the business conditions reading, most rankings are in the 90th percentile and higher. The exceptions are the relatively low rankings for exports with a 41.6-percentile standing and exporters sales with the 39.2 percentile standing.

However, there are also high standings for metrics that are not favorable for the outlook: labor costs have a 98-percentile standing, purchase costs have a 97-percentile standing, and prices have a 98-percentile standing. There are strong expectations for inflation and, in addition to that, stocks have a very high 99.2 percentile standing. If stocks are full, firms are less likely to be ordering and filling up inventories further.

Still, forward orders have momentum. In addition to moving higher, their percentile standing is at the 97.6 mark in its historic queue of data. The readings on activity and inflation both are high giving rise to some uncertainty about what the future will look like.

Looking at changed comparing three-month averages to six-month average, some of the biggest changes in these components have come from improvements in trading conditions and from stocks. In contrast, orders are only up by 0.3 points over three months compared to six months, one of the weaker categories. To the extent that some of this begins to look like congestion, the good news is that capital expenditures are relatively strong; the three-month to six-month change logs a 1.6-point gain, the fourth largest among business conditions components. Firms are investing.

One of the hallmarks of this report is that business confidence has been fading and it fell relatively sharply between August and September. But its smoothed three-month moving average climbs over three months compared to six months and over six months compared to 12 months. Over those periods business conditions themselves have been improving.