GDP was an estimated 0.5% below its third-quarter level in October, based on today’s news that services output fell by 0.7% between September and October together with earlier reports of changes of -0.7% and +0.6% in industrial production and construction output respectively. A quarterly fall in GDP, nevertheless, is not a done deal since monthly statistics are volatile and often revised heavily. The services PMI business activity index rose from 51.3 in October to 52.1 in November, suggesting a rebound in output.

Taking a step back, a 0.25% decline in GDP in the fourth quarter would imply full-year growth of 0.9% in 2011 – very disappointing relative to a consensus expectation of 2.1% at the start of the year. There are, however, two important qualifications.

First, part of the shortfall reflects a decline in North Sea production that should arguably be stripped out in assessing underlying economic performance. Gross value added excluding oil and gas is on course to rise by 1.3% in 2011 assuming a 0.25% fourth-quarter decline.

Secondly, there were two fewer working days in 2011 than 2010 – 251 versus 253, with one of the lost days due to the additional Royal Wedding bank holiday*. GDP statistics do not adjust for working days, implicitly assuming that lost output is recouped within the quarter or year. On an alternative assumption – admittedly equally arbitrary – that each lost working day leads to a permanent half-day loss of output, GDP growth in 2011 was depressed by about 0.4 percentage points (i.e. one day as a percentage of 253), implying a “true” rate of expansion of about 1.3%, or 1.7% excluding oil and gas. (The effect turns positive in 2012, when there are 252 working days despite an additional bank holiday to celebrate the Queen’s Diamond Jubilee.)

*The number of working days in 2011 was the lowest since at least 1967, according to the website www.work-day.co.uk. There have been two previous years since 1967 when the number of working days fell by two – 1977 and 2005. In both cases, GDP growth was lower than in the prior and following years.

Earnings downgrades by equity analysts slowed again in December, suggesting a further recovery in the G7 PMI manufacturing new orders index. The earnings “revisions ratio” – the difference between the proportions of estimate upgrades and downgrades, adjusted for seasonal variation – is only marginally below its long-run average and at a level consistent with a new orders reading above 50.


The US continues to lead the recovery in earnings and output momentum but Euroland is also improving at the margin, with a “surprise” rise in new orders in the December “flash” PMI manufacturing survey confirmed by a rebound in the revisions ratio.


Posts earlier in 2011 expressed concern about a Chinese “hard landing” but the judgement now is that risks are diminishing, reflecting a recovery in real money supply expansion. The Markit PMI new orders index remained weak in December but is not given weight here – the “official” PMI is more reliable and has displayed greater resilience, after seasonal adjustment. Korean exports to China ought to reflect any softness in domestic demand but picked up in the three months to November.

Banks borrowed €489 billion in the three-year operation but have repaid €307 billion of 12-month, three-month and seven-day money this week. The net increase in conventional lending, therefore, is €182 billion – smaller than the €278 billion resulting from the first 12-month LTRO in June 2009 but still substantial.

Banks have another chance to borrow for three years in February so there was no need to go “all-in” now.

The boost to bank reserves (i.e. balances in current accounts and the deposit facility) will be less than €182 billion to the extent that looser collateral requirements allowed banks borrowing under “emergency liquidity assistance” programmes to switch into the three-year operation – see previous post. The impact, however, should be at least €100 billion, implying that reserves will rise to well over €600 billion versus a previous record high of €529 billion in June 2010 (€512 billion last week).

The sustainability is open to question but the global economy is lifting in late 2011, as suggested by an earlier recovery in real money growth.

In the US, inflation-adjusted retail sales rose again in November while early December New York and Philadelphia Fed manufacturing surveys reported a further increase in order expectations, hinting at strength in ISM new orders.

While the Eurozone grapples with credit contraction, US bank lending continues to expand. Commercial banks’ loans and leases rose by 5.6% annualised in the three months to November, pushing the annual increase up to 2.2% – a three-year high.


Recent stronger demand for bank credit may partly reflect a rebuild of inventories, which should contribute significantly to fourth-quarter GDP expansion.


The inventory rebuild, in addition, may be boosting Asian exports, which were strong in November, with Taiwanese orders data today confirming an improvement.


It would be a stretch to suggest that the Eurozone is joining the party but last week’s flash PMIs seem consistent with an economy flatlining rather than heading into the abyss – at least for now. Today’s Ifo survey was also less dire than feared.


The onus is on central banks – specifically the ECB and PBC – to sustain global real money expansion in early 2012, especially with QE2-related US monetary buoyancy likely to fade.

This week’s three-year ECB LTRO (i.e. long-term refinancing operation) should lead to a substantial increase in lending to the banking system, thereby pushing Eurozone and G7 bank reserves to new records.
 
The ECB’s first 12-month LTRO conducted in June 2009 resulted in a €278 billion rise in both conventional lending (i.e. “related to monetary policy operations denominated in euro”) and reserves (i.e. balances held in current accounts and the ECB’s deposit facility). The lending increase reflected take-up of €420 billion under the LTRO offset by a €142 billion repayment of main (i.e. weekly) refinancing operations.

Banks are able to roll their existing LTRO borrowing into this week’s operation but are likely to demand additional funds because of the longer maturity and looser collateral requirements.

Changes in conventional lending usually have an equivalent impact on reserves since the ECB does not sterilise its refinancing operations. There may, however, be some slippage this week, to the extent that banks borrowing under “emergency liquidity assistance” facilities are able to switch into the three-year LTRO because of the loosened collateral requirements. Conventional lending, in other words, may rise by more than total lending (i.e. including emergency assistance) and reserves.

The impact, nonetheless, should be sufficient to push Eurozone reserves above their June 2010 high of €529 billion versus €474 billion last week, implying a new record also for the G7 total.