As projected in the May 2006 OECD Economic Outlook, activity in the OECD area as a whole is set to grow around potential during the second half of this year, with some gradual rebalancing between the two sides of the Atlantic. In this context, the recent data for the first half of 2006, indicating a much stronger than expected performance in Europe and a significantly weaker one in the United States and Japan, should not be merely extrapolated going forward.
Indeed, following this catch-up, growth is likely to slow somewhat in Europe whilst the US and Japanese expansions regain some momentum. As concerns inflation, price stability is still some way off in the United States and, in the opposite direction, in Japan.
The risks surrounding this scenario continue to include the evolution of oil prices, which oscillated between $70 and close to $80 during the summer. Another prominent set of risks relates to long-term interest rates and real estate, against the backdrop of cooling housing markets in North America.
The US economy is running at around full capacity. In the second quarter, investment weakened, dragged down by the homebuilding sector. Household consumption slowed less and has in fact tended to accelerate in recent months, consistent with a pick-up in compensation, and so have exports, pointing to robust GDP growth in the third quarter. Unemployment has edged up since spring but remains low. In the United Kingdom, growth continues to be resilient at around potential.
In Japan, momentum is driven by business fixed investment and household consumption. Corporate sentiment is holding up well, underpinned by strong profits and orders. Consumption is buoyed by employment creation and rising compensation. As a result, the expansion is on course to become the longest in half a century.
In the euro area, activity accelerated in the second quarter, partly catching up with upbeat business confidence indicators. Several transitory factors helped, notably the soccer World Cup and time-bound subsidies in the construction sector in Germany. Domestic demand in the euro area benefits from the pickup in employment growth in the two largest economies, and area–wide unemployment has fallen to below 8% of the labour force for the first time since 2001. Given the stronger-than-expected momentum in the first half, year-average GDP growth is now slated to reach 2.7%.
With most measures of inflation edging up, central banks across the G7 countries and beyond have lifted their policy rates since spring, but they face very different stages of the economic and interest rate cycles. In the United States, the Federal Reserve paused in August but further tightening may turn out to be warranted if activity and prices do not slow down over the next few months, as past interest rate hikes and housing market softening work their way through. In Japan, there is a strong case for waiting before further hiking the policy rate until the new series of core inflation (excluding energy and food) is firmly in positive territory. In the euro area, the recovery now seems sufficiently robust for a return towards a neutral monetary stance, but gradually so, since unit labour costs remain well in check.
On the public finance front, dynamic activity and rising asset prices have contributed to positive revenue surprises. As a result, the fiscal deficit in the United States and in a number of other OECD countries should come in below what had been budgeted. In particular, in several euro area members, the general government deficit will pass under the 3% of GDP mark. In general, however, the extra receipts should not be spent, since the pace of fiscal consolidation during this cyclical recovery has so far failed to live up to the public finance challenges stemming from population ageing and other medium-run pressures.
©OECD Observer, September 2006