Preview: US deficit risks adding to instability

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The recent rise in volatility across many financial assets and the accompanying re-pricing of risk reflects a bout of investor nervousness that could provide a foretaste of a longer period of uncertainty.

Robert Lind, economist at ABN Amro, views the recent rise in volatility as a reflection of worries over macroeconomic fundamentals. Mr Lind says: “We see global economic imbalances as the biggest threat to the stability of the world economy and financial markets.”

The US current account remains the chief imbalance in the global financial system. The consensus forecast is for the current account deficit to narrow from $225.6bn in the third quarter to $203bn in the fourth quarter data, released on Thursday. The full-year deficit, measured as a percentage of gross domestic product, would reach 6.5 per cent and ABN thinks it will widen to 7 per cent in 2007.

Mr Lind argues that the Federal Reserve and the Bank of England should be concerned about the potential for trade imbalances to generate inflationary pressure and currency weakness, particularly problematic as both economies are running close to full capacity.

Friday brings US inflation data, with the core rate expected to remain unchanged at 2.7 per cent in February, stubbornly above the Fed’s comfort zone. There has been a decline in core goods inflation, led by declines in vehicle prices but rents and medical care costs have continued to rise.

The US will also release retail sales data for February on Tuesday. Retail sales were flat in January but a stronger rise of 0.3 per cent on the month is expected for February. This would increase the year-on-year growth rate from 2.6 per cent to 3.7 per cent.

In the UK, manufacturers have been reporting increased confidence that they will be able to raise prices. This will feed through to output producer prices, although February’s data, released on Monday, are expected to remain unchanged at 2.1 per cent.

Sterling’s appreciation over the past year (about 5 per cent on the trade-weighted index) is affecting manufactured exports. Last year, the manufacturing goods trade deficit jumped by 25.4 per cent to £60bn.

The total trade deficit (goods and services) rose to £55.8bn, or 4.3 per cent of GDP, last year.

Survey evidence suggests manufacturers have achieved only modest increases in export orders. The official UK trade data for January, due on Tuesday, are not expected to show any improvement on December’s total deficit of £4.9bn.

However, Wednesday’s labour market data are potentially more significant as they could play an important role in determining interest rate expectations at the Bank of England. The government has already signalled its intention to restrain earnings growth with its public sector pay offer of just 1.9 per cent.

According to Incomes Data Services, median pay settlements rose to a five-year high of 3.5 per cent in the three months to January, one of the most important months for wage deals. In the official data on Wednesday, analysts will look at the growth in earnings excluding bonuses, which is expected to rise from 3.7 per cent year-on-year in December to 3.9 per cent. However, a higher figure would fuel concerns about the potential for an upward spiral in wages and prices.

In the eurozone, industrial output growth, due on Tuesday, is expected to rise from 4 per cent year-on-year in December to 4.1 per cent in January.

Germany’s ZEW survey of economic sentiment for March, due on Tuesday, is expected to show a small dip in the expectations measure owing to the recent turmoil in financial markets.

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