Where is the risk in global financial markets?

UK Weekly, Jul 13, 2007

Finally, for both the UK and the US there is the further risk that distress in segments of the financial market will have a knock-on effect on broader lending standards. This is not easy to quantify, but the relationship between US nonresidential fixed investment and credit standards in the Federal Reserve Loan Officers' survey may give us a clue. As mentioned earlier, in recent quarters lending standards for commercial and industrial loans have moved into broadly neutral territory after a long period of loosening. This is historically consistent with fixed investment growth around 6% per annum.

In periods of financial market turbulence such as late 1993 and late 1998 however, lending standards tightened sharply, and we estimate a repeat of such a 'spike' in risk aversion among credit institutions could see fixed investment growth halve from the 2005-2006 rates of 5.5-6%, reducing GDP growth directly by around 0.3%. Such a development would obviously be rather unwelcome, coming on top of the existing substantial drag from weak residential investment - it would likely mean a more prolonged period of sub-trend growth than currently envisaged by markets and by the Fed.

Latest data in detail

PPI inflation steady, input costs up...

June's PPI inflation was steady at 2.4% for the third consecutive month, against expectations that it was going to inch higher as manufacturers' price expectations have strengthened. However, input price inflation continued to rise on the back of high energy prices to 2.1% year-onyear in June, from 1.3% in May. Input prices rose by 0.6% on the month. The rise in input prices may be of further concern to the BoE. Should global commodity prices continue to increase, the disinflationary effect from cuts in utility bills contained in the May inflation report's CPI projections may be reversed.

...BRC retail sales pick up...

Retail sales growth accelerated in June, according to the British Retail Consortium. Total sales grew by 5.1% yearon-year from 4% in May. This figure supports surveys of services and retailers showing that consumers have not yet started to rein back on their spending. However, we expect retail sales growth to ease later in the year, as the impact of higher interest rates and sluggish income growth takes full effect.

...May trade deficit narrows...

The UK trade deficit narrowed in May to £6.29bn from £6.93bn, confirming indications that manufacturers are coping reasonably well with a stronger currency and higher interest rates. Exports rose by 3.5% to £18.2bn, while imports fell slightly to £24.5bn. The goods trade gap with non-EU countries, against which the pound has strengthened considerably, also narrowed to £3.48bn. However, April's deficit was revised up by £0.6bn to £6.9bn.

Housing market's mixed signals.

June's RICS housing survey showed a marked decline in the balance of Surveyors reporting a rise rather than a fall in prices to 10.6 from a downwardly revised 22.5 in May. We expect house price inflation to ease later in the year, as moderating demand, in the form of lower mortgage approvals, and affordability impact house prices.