Global Economic Overview: May 2014

Global Economy Rebounding from Winter Slowdown

Though first quarter growth in the U.S. and the Euro-zone was weaker than expected, more recent data indicate that global economic outlook has turned healthier. The U.S. economy unexpectedly contracted during the first three months of this year as the bad weather hurt domestic demand, but consumer sentiment has revived subsequently and manufacturing output has accelerated. Subdued growth in countries such as France and Italy led to a weaker than expected pace for the Euro-zone economy during the first quarter. On the positive side, the Japanese economy saw one of the fastest growth periods in recent years during the first quarter as businesses investments increased more than expected. The Chinese economy expanded faster than forecast while the growth trends from other Asian countries such as Korea, Taiwan and Indonesia were also positive.

Global manufacturing output continued to expand during May, helped by sustained uptrend in the U.S. Factory activity in the Euro-zone also expanded during the month while in China, output likely contracted less than the previous month. Japanese factory output also declined at a lower than expected rate, indicating expectations about a probable recovery in consumer spending. The European Central Bank (ECB) lowered its benchmark rate further as inflation remained well below its target rate. The ECB will also start charging interest on reserves maintained by commercial banks with the central bank, in a move to encourage more lending. Global equity prices advanced as market indices across all regions remained in an uptrend. Strong gains in India and China, as well as a rebound in Russian equity prices, helped emerging markets to outperform during the month.

Global Industry Spotlight for the Month: Retail

Large format retailing companies have had a difficult period after the global financial crisis as they tried to reorient their business structure towards changed consumer preferences. While the discount retailers performed relatively well, the large format department stores and select specialty retailers have struggled in the developed countries.

Like most other consumer oriented sectors, the retailing industry has struggled in its efforts to realign the business model with changed consumer behavior in recent years. The slow and uneven economic recovery in the developed world made consumers more cautious, as income growth stalled and credit standards became tighter. The U.S. labor market has seen a sustained revival only recently, while several countries in Europe still have substantially high unemployment levels. While fuel prices are below their pre-crisis levels, they are well above their historical trends and have hampered household budgets. Deleveraging by households to reduce their unsustainably high debt levels also dampened consumer spending in most developed countries.

Weak income growth and the economic uncertainties forced most consumers to downshift to lower priced products and services. This trend helped the discount retailers and they saw sustained above average same store sales gains until late last year, especially in the U.S. The luxury segment was relatively unaffected as high income consumers have seen relatively lower income uncertainties. As a result, sales of luxury goods continued to expand in recent years. Some of the luxury brands have even thrived, with some of the best revenue growth rates in their history.

The large developed countries have seen contrasting retail sales trends in recent months. While the U.S. economy appears to have rebounded from the winter slowdown, retail sales for the months of April and May have been softer than expected. Even the U.S. discount retailers have seen slower same store sales growth since the second half of last year. Japanese retail sales declined sharply in April as expected, after the consumption taxes were hiked earlier that month. However, sales trends have been more positive in Europe, despite the relatively more subdued economic conditions. Retail sales in the Euro-zone area increased for the third successive month in May, at a faster pace than expected. In the U.K., average monthly sales since the beginning of this year have shown appreciable improvement when compared to the same period of last year.

The retail sales growth outlook for the developed countries is likely to be driven by further labor market strengthening and monetary policy measures. Average monthly job gains in the U.S. have exceeded expectations and average incomes have seen modest gains in recent months. This could reflect positively on consumer sentiment, unless fuel prices appreciate substantially due to geopolitical risks in Russia and West Asia. In Europe, signs of improvement in the services sector may lead to an improvement in labor market conditions and help sustain consumer demand. In Japan, retail sales could recover as consumers get adjusted to the new tax rates and as additional stimulus measures are announced.

In the emerging market countries, domestic consumption growth is expected to be more restrained relative to recent years. Governments and central banks do not have sufficient flexibility to introduce stimulus measures. Credit growth has slowed in China after the central bank introduced tighter restrictions to curb the property price surge and the expansion of shadow banking. Borrowing costs have gone up in other countries including, India, Indonesia, and Brazil as their central banks tried to stabilize their currencies and contain inflation risks.

The growth of internet commerce has also transformed the competitive landscape in the retail sector. The decline of department stores can be partly attributed to the swift growth of internet retailers that have lower costs and higher pricing flexibility. In response, several large retailers have stepped up their internet sales in recent years. The companies that have been successful in this effort have seen a growing share of their aggregate sales coming from this channel.

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