RIYADH, 16 August 2004 — The global economic recovery map was painted red by three major events. First, the Fed hiked a quarter percentage point in the benchmark interest rate, taking it to 1.5 percent. Secondly, the US trade deficit exploded in the month of June to $55.8 billion. Finally, US oil prices rose to their highest ever crossing $46 per barrel.

The Fed rate hike came at a time when the markets although had some idea but expected it the least. It was perhaps due to a dismal employment report previous week, when the US economy created far fewer jobs than expected. The Fed had earlier indicated that it would hike rates by at least 25bps whenever they meet during the remainder of the year. The Fed has been citing stable performance of the US economy and believes that it’s on the path of recovery given it hit a soft patch in recent times.

The US economy suffered a nasty blow as it recorded its biggest drop in exports in three years and the biggest hike in imports. A drop of 4.3 percent in export in June was equal to a sharp plunge in September 2001 when the US economy came to a standstill after the terrorist attacks.

Also, imports climbed 3.3 percent to an all-time high. These factors took the US trade deficit to $55.8 billion in June. Experts had expected the deficit to expand but near the levels of $47 billion, instead it jumped 19 percent, clocking its biggest increase in more than 5 years. The ballooning deficit was attributed to surging prices of oil which was imported at record levels.

Also, US Treasury Secretary John Snow blamed weaknesses in the global economy especially Europe and Japan for the increase in the deficit. He indicated that although the US economy was on the track to recovery, weaknesses in its competitors’ growth was enabling Americans to buy more products from abroad. Also, US trade gap with China widened to a record $14.2 billion as imports from China peaked to an all-time high while exports eased. US manufacturers blame China’s undervalued currency for making Chinese products cheaper.

Analysts said that the trade gap would lead the government to cut down on its 2nd quarter economic growth expectations. This comes in contrast to expectations of an upward revision.

Surging oil prices which clocked their highest levels added to the nervousness in the global economic recovery. However a survey by the Wall Street Journal indicated that increase in oil prices may not hurt the US economic recovery unless oil prices reached $60 per barrel.

Elsewhere, Europe growth rate unexpectedly slowed in the 2nd quarter to 0.5 percent despite rising consumer spending in France and surging exports from Germany. Japan’s GDP also fell short of forecast and grew only 0.4 percent in the 2nd quarter. However, IMF (International Monetary Fund) raised its forecast for Japan in 2004 to 4.5 percent from 3.4 percent.

(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)