In the United States, according to the preliminary estimate, GDP grew 0.6% at an annualised q/q pace in Q1 2008, i.e. unchanged from Q4 2007. Domestic demand ex inventories contracted, for the first time since 1991, cutting growth by 0.5 percentage point, while the change in inventories and external trade enabled growth to remain in positive territory, by adding 0.8 and 0.2 percentage point, respectively. Moreover, recent data — such as the ISM surveys with the manufacturing PMI at 48.6 in March and April and the services PMI at 49.6 in March, the Employment Report (-61k in non farm payrolls on a 3-month moving average in April), retail sales and data covering the real estate sector — suggested activity contracted in Q2 08. Under these conditions, the Fed’s decision was hardly surprising, i.e. a 25-bp cut in the target Fed Funds rate, lowered to 2.0% and in the discount rate, down to 2.25%. The press release issued after the FOMC meeting had a more neutral tone. Indeed, it insisted on the Fed’s past moves and their expected effects. Lastly, the reference to the “downside risks to growth” was deleted. The forthcoming trend in monetary policy is more uncertain as we draw closer to the cycle’s trough. Nonetheless, further rate cuts remain likely, at a gradual pace. The European Commission released this week its latest growth forecast for the zone. It was lowered from 2.2% in November 2007 to 1.7%, after 1.8% was still projected in February. Moreover, GDP growth should slow further in 2009, sinking to 1.5%. These gloomier prospects were confirmed by recent data — European Commission survey, composite PMI output indicator, EuroCoin indicator and national surveys in France and Germany — which reported GDP growth was below its potential pace. Moreover, the Commission forecast that inflation will remain at a high level this year, 3.2% on average, before dropping markedly next year, down to 2.2%, a reading that would be more compatible with the ECB’s objective. In April, according to the flash estimate, inflation dropped noticeably to 3.3% from 3.6% in March. The decline was witnessed in all the countries for which data are already available, i.e. Italy, Spain, Belgium and, above all, Germany. German inflation fell back under the 3% mark, down to 2.6% in April from 3.3% in March, helped by favourable base effects. The cooling down of inflation in the euro zone, although it remains at a high level, combined with the slowdown in activity, is unlikely to induce the European Central Bank to raise its interest rates. Nonetheless, it will remain vigilant, and the tone of its policymakers’ statements will continue to be restrictive. Under these conditions, the monetary status quo will certainly be maintained next week and in the next few months, while a rate cut could be envisaged in late 2008, barring a faster deterioration in activity and/or an earlier slowdown in prices. In Japan, the BoJ published in the middle of the week its semi-annual "Outlook for Economic Activity and Prices" report. It revised downwards its growth forecasts for fiscal year 2008, which ended on 31 March, from 2.1% (projected in November 2007, to 1.5%, i.e. the median of forecasts of Monetary Policy Committee members). By contrast, it revised its year-on-year price forecasts upwards from the 0.4% it expected in November to 1.1%. Its growth forecast for fiscal year 2009, which began on 1 April, is 1.7%, and 1.0% for prices. Accordingly, “the economy [through fiscal 2009] is likely to continue its moderate growth at a pace around the potential growth rate”. The Bank of Japan believes the current economic environment is highly uncertain, adding that “it is not appropriate to predetermine the direction of future monetary policy”. This is because “future developments in overseas economies, global financial markets (turmoil) as well as high energy and materials prices” are downside risks weighing on Japan’s growth prospects. Therefore, in a very pragmatic approach, the Bank of Japan will “will implement its policies in an accordingly flexible manner”. We consequently expect it to maintain its monetary policy unchanged for a long time. To view the charts and graphs please open the PDF file on the left.

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