Friday, April 27, 2007

A Tale of Two Economies

US first quarter GDP figures came out today. Their economy grew by an annualised equivalent of 1.3% in the first quarter (i.e. a growth of 0.323% during the first three months of the year). At the same time Core US inflation (i.e. excluding energy and food) rose to 2.2%, while the GDP deflator increased to 4%, the highest in 16 years.

All of which leaves the Fed in a very uncomfortable situation. Unlike the BoE, the Fed has twin goals - to keep growth going and to keep inflation low. The need to keep inflation low usually trumps keeping growth going (as it is hard to rein in once it has started), which means the Fed will probably opt to keep their interest rates where they are, rather than cut as the markets anticipated last year. How a slowing US will fare with interest rates staying pat is anyone's guess. There's much chatter at the moment about why it doesn't matter, because pundits believe that the world economy has decoupled from the US one. But the US economy is not only very very large (a $12 trillion economy), much of the world (especially Asia) is dependant on it. It's hard to see a slowdown in such a large chunk of the world's economy not affecting the rest.

In the UK meanwhile, first quarter growth came out at 0.7% (or 2.8% annualised equivalent) - about double the US rate. Our headline CPI (including energy and food) came out at 3.1%.

Energy costs look like they will come down though. Two months ago British Gas announced it would cut gas prices by 17 per cent and electricity prices by 11 per cent. Yesterday it said it would cut electricity prices by a further 6 per cent, and gas prices by a further 3 per cent, with immediate effect. EDF today announced they would be cutting too. Of the big six energy companies, only Scottish Power has not announced a cut. However, Scottish Power did say that it's customers "could expect good news soon".

All of this should start to cut the CPI. I expect the BoE will still raise rates to 5.5% in May to demonstrate that they take inflation-fighting seriously. But they will at the same time be keeping a worried eye on the Americans.

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