A further break of links between unemployment and inflation may be on the cards next year, helping economies such as the UK and US to outperform, according to L&G.
Its latest top-down analysis of the state of the UK and global economies suggests services-based economies, like the UK, are going to be increasingly able to charge more for their output relative to manufacturing-based economies, which may experience deflationary pressures building up.
Essentially this means where the UK will be able to keep charging more for its services-based output, countries such as China will face increasing competition and falling prices. The gap between the two types of economy will widen as time moves on.
Julien Garran, L&G Investment Management chief strategist, points out this also means L&G is taking a contrary line to many market pundits in forecasting a strong US rebound through next year. Otherwise, many see the current malaise in the US residential housing market as a sign the US consumer will pull back and send the economy into a funk.
This will not happen Garran says, partly for the reasons outlined above, but also because evidence suggests companies in the US are actually increasing salaries faster than previously throught, which is likely to feed through in the form of more robust US personal consumption, hence supporting faster economic growth through 2007.
The US in fact is set to go through a “cross-over” period against Europe, which has outperformed most expectations this year. Europe will, however, see its growth rate stagnate as the US steps up a gear.
Focusing back on the UK, the macro-economic figures suggest growth will be better than expected through next year as the economy reacts to two major factors: there are more people working to older ages, while recent high net immigration has given a boost to overall employment numbers.
Some of the evidence is in the form of rising issuance of National Insurance numbers, required to work legally in the UK, coupled with Office for National Statistics figures suggestion overall economic activity continues to climb.
Then there is the suggestion the link between unemployment and inflation has been broken. Figures suggest while the natural rate of unemployment has remained fairly constant at a level of about 3% since the early 1990s inflation has not. Instead, the official measure of inflation has fallen from a level of about 10% then to a range of between 2-4% in the past seven years.
L&G says this constitutes further evidence the so-called Phillips Curve has weakened, in effect enabling economies to grow both GDP and employment at the same time, and not having to suffer a certain level of unemployment to obtain a certain stability in inflation. The ability to grow faster without suffering rising inflation will also play into the hands of those investing in UK equities as interest rates will not have to rise as fast.
Large-cap growth stocks are most likely to benefit, such as pharmaceuticals.
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