Industrial production increased 0.4% in December after a downwardly revised 0.1% drop in November (previously estimated as a 0.2% increase). Factory production rose 0.7% in December compared with a steady reading in the prior month. Factory output in November was previously estimated as a 0.3% increase. Total factory production dropped at an annual rate of 1.3% in the fourth quarter vs. a 4.3% increase in the third quarter. The main message is that there are pockets of strength in the factory sector maintaining momentum but it there is no widespread robust growth.
The strength in the December report was from a 2.6% increase in auto production leading to an increase in auto assemblies to 11.33 million units vs. 10.96 million in November. In 2006, auto production declined in three quarters and held steady in the second quarter. Lean inventories at the retail level due to incentive driven sales has led to a tentative jump in auto production. In addition to auto production, the high-tech sector contributed to the overall increase in factory production with a 2.2% increase in production. Excluding autos and high-tech, total factory production rose 0.4% in December, reflecting 1.6% increase in the primary metals component and a 1.2% increase in machinery. Excluding autos and high-tech, factory production fell at an annual rate of 3.3% in the fourth quarter vs. a 4.0% increase in the third quarter.
Production of furniture and related products fell 0.9%, with the drop in the fourth quarter at 1.7% marking the fourth quarterly decline in the last five quarters. Although construction supplies show an increase of 0.3% in December, on a quarterly basis, this component posted a 2.4% drop, also the fourth quarterly decline in the last five quarters.
The operating rate of the factory sector moved up in December to 80.4 from 80.0 in the prior month. In 2006, the capacity utilization rate at the nation’s factories rose to a cycle high of 80.5 vs. 78.8 in 2005. The upward trend of the operating rate is on the watch list of the FOMC. The good news is that the peak operating rate was in August at 81.1.
Core Wholesale Prices Maintain Upward Trend
The Producer Price Index (PPI) for Finished Goods moved up 0.9% in December after a 2.0% jump in November. The energy price index increased 2.5%, following a sharp 6.1% gain in the prior month. The food price index rose 1.7%, reflecting higher prices for a variety of food items including a 21.7% increase in prices of vegetables after a 14.2% drop in November. The Producer Price Index for Finished Goods has risen 1.1% in 2006 compared with a 5.4% gain in 2005. Lower energy prices are the reason for the significant moderation in overall wholesale prices. The energy price index was up 23.9% in 2005 vs. a 2.0% drop in 2006. A drop in energy prices is most likely in January. The FOMC is mindful of the slightly upward trend of core wholesale prices but core consumer price hold the key in policy decisions.
The core PPI excluding food and energy increased 0.2% in December, putting the year-to-year increase at 2.0% vs. a 1.4% gain in 2005. Car prices fell 0.2%, while light trucks (+0.7%) were more expensive in December vs. November.
The intermediate goods price index advanced 0.5% and the core intermediate goods price index fell 0.1% in December. The crude goods price index and the core goods price measure rose 1.9% and 1.0%, respectively, in December.
NAHB Survey Results Conflict with Comments from Builders
The National Association of Home Builders’ survey results for January are far more optimistic than quarterly updates of home builders reported in today’s Wall Street Journal (http://online.wsj.com/article/SB116894736306777548.html?mod=todays_us_page_one ) and other news stories of the past few weeks. The Housing Market Index (HMI) rose to 35.0 in January from 33.0 in December. The bottom for this series was established in September at 30.0 (see chart 5). The January reading reflects improvements in present sales (36.0 vs. 33.0 in December) and traffic of prospective buyers (26.0 vs. 23 in December). The housing starts estimates for December will be published tomorrow.
UK: Reasons for Last Week’s Rate Hike
The reasons for last week’s surprise 25bp rate hike from the Bank of England (BoE) are starting to become pretty clear. Inflation jumped more than expected in December, right before the crucial January pay round, and just as the labor market may be tightening again.
Yesterday we learned that (EU-harmonized) consumer price inflation hit an annual 3.0% in December – the highest since the series began in January 1997, and once again above the BoE’s 2.0% target. BoE Governor King was saved the embarrassment of having to write an explanatory open letter to the government – just. If CPI deviates by more than one percentage point either way from the target (i.e., if it hits 3.1%), the Governor has to publicly explain why, what the Bank intends to do about it, how long it will take to get back to the target, and how the Bank’s strategy meets the government’s monetary objectives. No governor has yet had to write such a letter.
In addition to the CPI numbers, the members at last week’s Monetary Policy Committee (MPC) meeting will also have seen the data on December’s retail price inflation, which hit a 15-year high of 4.4%, up sharply from 3.9% in November. The RPI measure is the one most often used in setting wage deals – hence the MPC must be concerned about the threat of wage-push inflation.
Today’s average earnings data for September-November was fairly sanguine – an annual increase of 4.1%, the same as in August-October. While this is down from the peak of 4.4% seen mid-year, the trend appears to be heading upward again. More to the point, with RPI jumping so sharply at year-end, January’s pay deals could be far higher.
As to the labor market, the number of people claiming jobless benefits fell by 5,500 in December, while November’s drop was revised from 5,700 to an even sharper 7,900. Claimant count unemployment has now fallen for three months in a row. The internationally-comparable ILO measure of unemployment for September-November remained at 5.5%, the same rate as in the June-August period.
The BoE had anticipated an inflation spike around the turn of the year, but December’s data seems to have surprised on the upside. All told, at least one more rate hike is likely before end-Q2.
Japan: Will The New Year Be Full Of Old Problems?
One year ago we had turned cautiously optimistic about the Japanese economy and were penciling in the likely schedule for the Bank of Japan’s (BoJ’s) inevitable rate hikes during 2006. What a difference a year can make. The BoJ did in fact raise its overnight rate by 25 basis points in July, but subsequent tightening never emerged as some sectors of the economy began to soften. Now it appears that the overall economy is slowing down, and we might be headed for a brief period of limited – or perhaps negative – economic growth. One year ago we were on the verge of saying Japan had finally emerged from years of deflation and stagnating growth. Now we are considering the possibility that this slowdown is just like so many others.
Regarding Japan’s economic fortunes, there are two indicators that concern us at this time. First is real money supply, which should be on the rise when an economy is gaining steam. Between 2003 and 2005, real money supply had been growing at about 1.5-2.0% thanks to virtually no inflation at the consumer level. However, in 2006 consumer prices began to rise on a year-over-year basis at about the same time that the BoJ drained off liquidity in preparation for its July rate hike. Inflation rose by 1.3 percentage points in the 12 months to November 2006, while nominal money supply growth dropped by 1.4 percentage points during the same period. The result? Real money supply growth fell briefly into negative territory for the first time since 1993 – not the best thing for a growing economy.
The other indicator that raises our eyebrows is core machinery orders. This has been one of our favorite leading indicators for the Japanese economy, and as of late it has not given us very promising signals. On a year-over-year basis, this admittedly volatile series has not climbed above 0.7% growth for the past five months, and a base effect shift suggests that the December data (due for release in mid-February) will send figures sharply into negative territory barring some unexpected surge. Since the collapse of the Nikkei over 17 years ago, a sustained year-over-year contraction in core machinery orders has come with recession – either as a leading or a coincident indicator. This indicator is on the threshold of a sustained contraction, but nothing that compares with the past three recessions – yet.
After running our proprietary model for Japanese GDP, we have come to a few conclusions. First, fourth quarter GDP is likely to contract, but not by the 1.1% quarter-on-quarter rate required to drag the year-over-year change into negative territory. Export growth will be the main economic driver for Q4, but weakness in domestic demand will take a significant toll, as will the recent moderation of fixed capital formation. Second, these soft indicators will give the BoJ ample reason to put aside the topic of future rate hikes. Consumer inflation peaked at 0.9% on the year in August and has since slowed to 0.3% in November, leaving no justification for tighter monetary policy.
Unfortunately, there are few tools available to the BoJ to rekindle economic activity. The central bank would lose the credibility it had reclaimed over the past year if it reduced the overnight rate back to 0.001%, so direct interest rate adjustment is a non-starter. More than likely, the BoJ will have to resort to talking up the soundness of the economy during the current lull and hoping that the production environment does not deteriorate any further. As for us, we are not penciling in a recession quite yet, but we are far less optimistic than we were at this time last year.
