Assessment of Macroeconomic and Monetary Developments
Developments in the Global Economy
36. Global expansion appears to be proceeding at a strong pace in 2006 and is getting diffused across the main economic regions. According to the World Economic Outlook of the International Monetary Fund (IMF) released in April 2006, global growth is expected to pick up from 4.8 per cent in 2005 to 4.9 per cent in 2006 before easing to 4.7 per cent in 2007.
37. Global growth accelerated in the first half of 2006. In the US, real GDP increased by 5.6 per cent in the first quarter, led by personal consumption expenditure, exports and federal government spending. The US economy is expected to grow at 3.4 per cent in 2006 and remains the main engine of global growth. In the euro area, a recovery is underway with first quarter real GDP growth at 1.9 per cent and projected to rise to
2.0 per cent in 2006. In Japan, the recovery is gathering momentum, and there are encouraging signs that the economy has emerged from the debt-deflation spiral of the past decade. In China (11.3 per cent in the second quarter), Hong Kong (8.2 per cent in the first half) and India (9.3 per cent in the first quarter), the rapid pace of growth appears to have picked up further. In Russia and Latin America, too, growth has been buoyant.
38. Substantial increases have occurred in a wide range of commodity prices. While prices of oil and metals continue to be the main drivers, food prices have started edging up. Crude oil prices surged since April and almost doubled over the levels recorded in the last two years, touching a high of US $ 76.7 per barrel on July 13, 2006. The international pass-through of oil prices to domestic retail prices has been varied across countries, with implications for future inflation. World cereal production, in particular, wheat and coarse grains, is expected to decrease in 2006, leading to a drawdown of stocks for the second consecutive year. Prices of rice and wheat, in particular, are expected to harden on strong demand growth, high input prices and low global stocks. Non-energy prices have been increasing through 2005 and the first half of 2006. In fact, the recent turmoil in global markets appears to have been triggered by key commodity prices. Global metal prices rose by 48.4 per cent on an annual basis during the first six months of 2006 on top of an increase of 26.4 per cent in 2005. Metal price movements in recent months have been characterised by a heightened degree of volatility.
39. Consumer price inflation in the advanced economies accelerated in the second quarter of 2006. In the US, consumer prices rose to 4.3 per cent in June from 3.5 per cent in April, primarily on account of energy prices. In the euro area too, inflation rose to 2.5 per cent in May and June from 2.4 per cent in April. Consumer prices continue to increase moderately in Japan, i.e., by 0.6 per cent in May on account of higher oil prices. In the UK, inflation breached the Bank of Englandís target of 2.0 per cent in April and rose to 2.5 per cent in June. In major industrial countries, inflation appears to be on the upswing mainly on account of oil price increases. In addition, risks loom large in the form of lagged second order effects of oil price increases, geopolitical tensions, the probability of disruptive adjustment of current account imbalances and the cooling global housing market. Inflation expectations have also been reflected in the gap between nominal and inflation-indexed bonds which hovered in the range of 2.2-2.7 per cent in the US in May-July.
40. Global imbalances, emanating mainly from the twin deficits of the US and reflected in misalignment of major currencies, have continued to widen during 2006 in an environment of rising interest rates worldwide and prospects of contraction of liquidity in the global financial markets. The current account deficit of the US surpassed US $ 800 billion in 2005, matched by increased surpluses elsewhere, particularly in Japan, Europe, China and other parts of emerging Asia and oil-exporting countries. The IMF projects that the U.S. current account deficit will remain at about 6 per cent of GDP into the medium term, with some improvement in the U.S. fiscal position offset by low private savings and rising interest payments. The sharp rise in the net foreign liability position of the US raises the risks of abrupt and disorderly adjustment of major currencies as the global imbalances unwind.
41. Financial markets are becoming increasingly apprehensive about the risks of a disorderly adjustment of the widening global imbalances. Adverse expectations of markets were recently evident in the large declines in stock exchanges across the globe and a visibly increased preference for debt. Long-term sovereign bond yields, which had moved up briefly, have again fallen well below their long-run averages and yield curves have either flattened or inverted in major industrial economies. Ten-year bond yields in Japan, the euro area and the US currently stand at 1.79 per cent, 3.95 per cent and 5.05 per cent, respectively.
42. Against the background of these global developments, a large number of central banks have raised their official interest rates from the unusually low levels that they had reached earlier in the decade. They include the US Federal Reserve (by 25 basis points each on seventeen occasions from June 2004 to 5.25 per cent by June 2006); the European Central Bank (ECB) (three times since December 2005 by 25 basis points each to 2.75 per cent); the Bank of Japan (uncollateralised overnight rate to 0.25 per cent in July after maintaining a zero interest rate policy since 2001); the Bank of Canada
(by 50 basis points in April-May, 2006 to 4.25 per cent); the Reserve Bank of Australia (by 25 basis points in May 2006 to 5.75 per cent); the Peopleís Bank of China (lending rate raised by 0.27 percentage points to 5.85 per cent on April 28, 2006; required reserve ratio by 50 basis points on July 5 to 8.0 per cent and a further increase of 50 basis points to become effective from August 15, 2006); the Bank of Korea (by 25 basis points
to 4.25 per cent in June); and the Banco Central de Chile (benchmark lending rate raised to 5.25 per cent on July 13, 2006).
43. Some central banks have kept their policy rates steady as for instance, the Bank of England (repo rate at 4.50 per cent since August 2005); Bank Negara Malaysia (policy rate at 3.5 per cent since April 2006); the Bank of Thailand (the 14-day repurchase rate at 5.00 per cent since June 2006); and the Monetary Authority of Singapore.
44. A few central banks have eased monetary policy in the recent period such as the Banco de Mexico (cut the benchmark overnight lending rate from 7.50 per cent to 7.25 per cent in March 2006 and further to 7.0 per cent in April 2006); Bank Indonesia (reduced its policy rate from 12.50 per cent to 12.25 per cent on July 6, 2006); and the Banco Central do Brasil (cut Selic rate target gradually from September 2005 to 14.75 per cent by July 2006).