A year after the crunch hit, the world economy is looking tattered around the edges and growth is searching for new lows.

Inflation and unemployment are both on the rise as growth heads south, along with house prices and the prices of a wide range of other assets.

Now the question in more and more economies is; has the recession started?

The ‘R’ word is already being used to describe Japan, New Zealand and parts of Europe. 

Next the UK, the US (which has already flirted with a contraction in the last quarter of 2007) and Australia?

Overnight the Bank of England left its key interest rate on hold at 5% as it watched the British economy slide further. 

In doing that it joined the US Fed and the Australian Reserve Bank in resisting any urge to change rates.

And the European Central Bank also left its key rate steady at 4.25% and questioned whether growth in the eurozone would hold up in coming months. The answer to that query seems to be ‘no’..

But while the European, UK, British and Australian economies are all showing signs of weakness, only the RBA had to policy room to switch to a rate cut stance, and signal it vigorously.

The Reserve Bank publishes its latest economic and inflation forecasts next Monday and the Bank of England does likewise.

It will be easy to see from reading both statements, just which is the better placed economy (Australia) and which central bank has more room to move in future months to accommodate any further weakness (Australia).

The UK remains strangled by plunging house prices. 

The house price index published by the mortgage lender Halifax on Thursday showed prices fell a further 1.7% last month, contributing to a year on year fall of 11% for an average house.

That means prices have returned to the level they were at more than two years ago.

Investment bank, UBS has dropped its world growth forecast and says global economy is “precariously close” to a recession in 2009.

UBS said as it cut next year’s global growth forecast due to the continuing US slowdown.

UBS said it sees the world’s gross domestic product growing by 2.9% next year, down from an earlier prediction of 3.1%. UBS said it considers a 2.5% global growth rate as one that is consistent with a recession.

“Softer global economic activity for longer suggests peaking and then declining inflation. A sustainable recovery of ‘risk’ assets probably requires policy recognition that the primary macroeconomic challenge remains weak growth, not temporarily high inflation.”

“After some rather dismal high frequency data, especially the surprisingly weak US consumption data, we have decided to shave our US average growth forecast for 2008 by 0.3 percentage points to 1.3%.

“Our expectations for the business cycle this year remain unchanged: negative or insignificant growth rates in the first half, a rebound in the third quarter and a return to low growth at year-end and into 2009.

“Europe’s business cycle trails the US cycle by two to three quarters.

“We have trimmed our 2009 growth forecasts in particular, down from 1.7% to 1.2% now for the EMU.

“We have also downgraded Japan in view of its uninspiring domestic demand data as well as the strengthening of the yen. Growth in the large emerging markets remains healthy so far.”

“Until policy stances shift, credit and equity markets will have to contend with cyclical weakness and probable earnings downgrades, in particular for 2009 estimates.”

According to a report from the IMF on July 17, the global economy will expand 4.1% in 2008, and 3.9% next year, as it increased its estimates from projections in April.

 

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The European Central Bank (ECB) left its rate steady as it, like the US and the UK had to face up to the twins problems of a slumping economy and persistently high inflation.The ECB lifted its rate by 0.25% last month and there are those still wondering if that was a rise too many.

Those who say that point to economic activity across the region slowing, especially in Germany where second quarter growth is almost certainly to have contracted by around 1%.

At 4.1% inflation in the eurozone is more than double the ECB’s target of “close to, but just below 2 per cent”, but it’s less than the US rate of 5%, and Australia’s rate of 4.5%.

German manufacturing orders intake dropped 2.9% in June from May: UBS said this was the seventh consecutive drop in orders and the result was much weaker than expected.

“(The) weakness was driven largely by foreign orders, especially from other Eurozone countries. The numbers bode ill for production in coming months.”

Germany seems to have hit a big hole as its export driven economy is hit by the growing global slowdown. German economic growth will be down when the second quarter figures are released shortly, compared to strong growth in the first three months. 

 

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In London The Bank of England decision on rates was overtaken by the International Monetary Fund which delivered some bad news to the British Government that the BoE has undoubtedly delivered, but not been acknowledged.The IMF slashed its growth forecasts for the British economy and said that high inflation argued against a cut in interest rates by the Bank of England. The central bank obviously listened to that part of the IMF message.

The Fund now expects 2008 economic growth to be an annual 1.4%; falling to just 1.1% next year: that’s down from the 1.8% and 1.7% forecasts last month.

“So far in 2008, evidence points to a sharp slowing in activity alongside higher inflation,” the IMF said in a report on the UK economy.

The report made no reference to a recession, which an increasing number of economists are predicting.

The IMF forecasts for growth differ from those of the British government, which still sees expansion of 2.0% this year, rising to a giddy 2.5% in 2009.

The IMF argued that there was little room for easing interest rates despite the boost that such a move would give to economic activity.

“Given the outlook for inflation and the stance of fiscal policy, directors saw little scope for monetary easing at present,” said the report.

UK inflation jumped to a 16-year high point of 3.8% in the year to June (still under the 5% in the US and 4. 5% here, though).

But the Bank of England policy makers decided that the least-worst option is to do nothing.

They are a bit like rabbits looking at the soaring inflationary pressures, and the plunging economic performance, especially in housing.

The nine-member Monetary Policy Committee, led by Governor Mervyn King left the key UK interest rate at 5% for a fourth month in a row. That’s despite the news of another big fall in UK house prices.

A year after global credit crunch erupted and markets seized up, Britain’s economy is on the brink of a recession, and inflation will soon more than double the 2% central bank target.

UK services, manufacturing and construction shrank in July, consumer confidence again fell and house prices continue to fall: much like America.

 

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The Fed stayed its hand on interest rates this week, worried by both the continuing credit crunch driven recession and the still concerning level of inflation.So the Federal Funds Rate remained unchanged at 2%.

In Australia the Reserve Bank also left rates unchanged but sent the clearest signal for seven years that rates would fall, with September nominated by the market for a cut of up to 0.50%.

Inflation remains a concern and domestic growth is rough, but the iron ore, coal, oil and gas sectors are holding up the economy.

Japan sort of wandered into recession and South Korea put up interest rates while closer to home New Zealand seems poised to enter a recession (see below for reports).

In the US we got more reminders of just how far the US housing industry still impacts on financial groups and raised the strong possibility that worse was the come.

And July retail sales were poor in the US as the tax rebate boost faded: even Wal-Mart cut its outlook. Expect more poor news in the coming weeks.

Citigroup reached a huge $US20 billion-plus settlement to make a securities problem with authorities go away: it will probably mean a third quarter loss.

And the world’s biggest insurer, American International Insurance Group (AIG) and the US mortgage insurer, Freddie Mac revealed write-downs and losses on housing-related securities and other bits of paper of more than $US15 billion. AIG had losses of more than $US12 billion, Freddie Mac, over $US3.5 billion.

AIG reported a $US 5.4 billion second-quarter loss, but more worrying was the news that underlying earnings (excluding the write-down losses) fell into the red by far more than analysts had speculated: $1.32 billion as rates fell and the credit crunch hit returns on the insurers own funds (something we have seen here with Suncorp and IAG).

Overall AIG’s loss represented a near $US10 billion turnaround from the $US4.28 billion second quarter profit last year. Its shares fell sharply Thursday night in the US.

But it was Freddie Mac, the smaller of the two quasi-US Government sponsored companies (Fannie Mae is the other) which stunned US markets with a loss and write-downs much larger than anyone had thought.

It lost $US821 billion in the second quarter, and the shares again fell. The company now has a market capitalisation of $US4.6 billion at the end of trading this morning. That’s supporting over $US1 trillion in mortgages.

The group slashed its dividend to just 5 US cents a share and will save $US500 a year (why didn’t it just cut it completely?). It said it could raise $US5.5 billion in fresh capital, right now, but the market conditions were not welcoming.

But that would see existing shareholders suffer a 100%-plus dilution

But the real message from Freddie Mac’s result was buried in the detail. For the first time it has started writing down the value of home mortgages in its so-called AltA class: they are better quality than subprime, but are not prime mortgages.

It wrote those down by $US1 billion, and provided a further $US2.5 billion for more credit losses in other parts of its mortgage portfolio.

Freddie did this because it sees a deteriorating outlook for house prices and delinquencies and it is preparing itself for even worse news on falling home prices.

Freddie reckons that America’s housing crisis was only at its half-way point, with prices expected to decline nationally by up to 20% before the market stabilises.

Freddie estimates that US house prices have fallen by about 9%, while the broader Case/Schiller index says they are down 15.8% over the past year to June.

 

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Japan might be in a technical recession, but such is the country’s unreliable statistics, that it could be merely emulating the US and bouncing along the bottom of a nasty trough.

The Government has now conceded that the economy is “deteriorating,” an admission that the economy has entered a downturn.

This compares to its assessments for April and May when the government said that that, “a change in the phase of the economy may have taken place.”

But unlike what the US, UK, parts of Europe and Ireland are experiencing (and they are not officially in a recession), Japan is merely going through a period of sub par growth, but Japanese standards.

Unlike the US or the UK, Japan is not suffering from a house price bubble or credit crunch: its banks have escaped much of the damage done to those in the US and UK.

Export markets in Asia are still growing, slowly and yes exports to Europe and the US have turned down (the US for 10 months now), but the economy doesn’t need any pre-election stimulus from a nervy government desperate to buy its way back into Japanese voters hearts, nor does business need a big dollop of help.

Japanese business is on the whole, trim, financially fit, with low debt, and capable of powering through the slowdown.

Apart from groups (fishing people) hurt by high energy prices and higher food costs, the Japanese economy is in mostly good shape;if you exclude the still huge central government deficit and years of inept reform we in Australia have subjected ourselves over the past two decades.

The usual definition of a recession is two consecutive quarters of negative growth, but in Japan first quarter growth was an unusually strong 4%, so two negative quarters, and even a third that’s negative, won’t change very much.

In the long recovery and expansion period now coming to an end (in the minds of the Japanese Government) Japanese growth barely broke above 3%.

The usual range was 1-3% a year, so a year of 1% or even half a per cent growth is not the end of the world.

Inflation is a problem for everyone and will continue to intensify until the end of the year: but its relative, Japanese core inflation (after food and energy is discounted) rose by 0.1% in June. That’s higher than the near endemic deflation we saw for much of the past decade or more.

But activity in Japan is slowing: industrial production has now fallen for two quarters in a row; consumer confidence has fallen, wages a falling again and exports are weak.

It’s more a list of missed opportunities rather than direct consequences of some tremendous economic blow of the kind the US and Europe are reeling from.

Compared with a long list of countries like Ireland, New Zealand, the US, UK or Spain or Italy, (which are battling inflation a housing slump and the credit crunch which won’t relax its grip), Japan’s problems are minor. Much like ours in Australia at the moment.

Japanese companies are still exporting, though not to the easy market that was the US in the same quantity. Toyota’s latest figures are testimony to the damage the US has done to Japanese exporters (See below).

But job demand is still stronger than it was in the 2001 recession, machine tool orders fell in June, but by far less than expected (2.6% down compared to expectations of a 9.9% slide).

The bank of Japan will come under pressure to cut its key rate from the present 0.50%, but there’s really no need, even by Japanese standards.

 

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Toyota stayed out of the red in its first quarter to the end of June; unlike its big US competitors and it’s more confident about its outlook than BMW, Ford, GM and a clutch of competitors.

BMW reported a surprise 44% drop in first quarter earnings and abandoned its 2008 profit forecast; Toyota revealed a 28% drop in first quarter profits but maintained its full year estimate.

It was the second quarter in a row that the car maker’s profit had fallen short of the same quarter of the year before. The final quarter of the 2008 year saw earnings down.

The fall in the world’s biggest automaker’s quarterly net profit was less than forecast, but the damage from the strong yen and the massive slump in US car sales was still there for all to see.

While Toyota’s sales in China, Russia and the Middle East are growing faster than forecast, the company and other car groups face a downward sales spiral in North America, Western Europe and Japan, the weaker dollar that drags on earnings, and dearer raw materials (especially steel and plastics).

And then there’s oil which is making life miserable for car groups in every western economy.

Toyota last month cut its 2008 global production and sales forecasts and outlined plans to shut US plants building light trucks such as the Tundra pickup. Toyota is switching one of these plants to the production of the Prius hybrid in the US from around 2010.

The carmaker cut its 2009 financial year sales forecast to 8.74 million from 9.06 million. It dropped North American sales forecast to 2.63 million from 2.77 million.

In America Toyota is heading for its first fall in annual sales since 1995. Falling demand for trucks and sport-utility vehicles caused Toyota’s US retail sales to fall 7.8% last quarter, led by a 20% drop in demand for light trucks.

Toyota joined rivals Honda and Nissan in reporting damage to first quarter figures from the US slump.

Toyota’s April-June net profit was 353.66 billion yen (or $US3.23 billion), down from a record 491.5 billion yen a year ago but higher than market estimates.

Operating profit, which excludes earnings in China, fell 39% and more tellingly, revenue fell 4.7%.

For the year ended March, 2009, Toyota maintained its forecasts for a net profit of 1.25 trillion yen and operating profit of 1.6 trillion yen, down almost 30% from the year to March, 2008, and the first fall since 2002.

Toyota shares have dropped by around 25% in Tokyo, far less than the dramatic falls seen in the prices of General Motors and Ford. GM shares fell to their lowest level since 1954 in early July.

 

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Meanwhile official rates rose in South Korea yesterday to the surprise of markets.

The Bank of Korea raised its main rate by 0.25% to the highest in almost eight years, as it tries to slow inflation, and provide some support to a still weak currency.

The bank lifted its seven-day repurchase rate to 5.25%.

The country joins India, Indonesia, Taiwan, Thailand, Vietnam and the Philippines in boosting borrowing costs this year to try and control rapidly rising inflation.

China has tried squeezing the lending ability of banks and hasn’t moved rates. China’s reserve asset ratio for banks is 17.5%, but there are signs of a relaxation happening with export rebates on textiles being lifted in recent days.

South Korean consumer prices rose 5.9% in July from a year earlier. That rate was above the central bank’s target of 2.5% - 3.5% for a ninth successive month.

The economy grew 4.8% last quarter, the weakest pace since the first three months of 2007.

Not helping has been political instability around the administration of President Lee Myung Bak who has been forced to rein in his strong pro-growth policies to try and control inflation and the currency.

Protests from the public over US beef imports and the rapid rising cost of living and other issues have not gone well for the President. His popularity has slumped.

His unpopularity, the fear of political uncertainty, and the high inflation have helped produce an 8% drop in the value of Korea’s won against the US dollar this year.

That has added to the cost of imports of food and energy, two of the big drivers of inflation.