On a quarterly basis, Japan followed by Italy recorded the fastest growth. In order they were followed by Germany, the UK and France. The U.S. and Canada grew at the slowest pace of the G-7. This is a substantial change from the third quarter when the UK, Canada and the U.S. grew the fastest and France, Italy and Japan barely eked out a positive result. Germany has reestablished itself once again as a growth leader - it grew the fastest of the four European countries here for all four quarters of 2006.

Europe continues to improve
EMU - In 2006, European Monetary Union (EMU) was made up of 12 national economies and relied on Germany, France and Italy to stimulate growth. (Slovenia joined the EMU on January 1, 2007 and all data going forward will include 13 Member States.) The U.S. set the pace for year over year growth for the first half of 2006 but lagged the EMU for the second half for the first time since the fourth quarter of 2001. When compared with Japan, the picture is somewhat different however. On the year, the EMU grew faster than Japan for the last three quarters of 2006.

While part of the EMU's problem continues to be structural in nature some progress has been made. Another part of the problem is the dichotomy between fiscal and monetary policy. While the European Central Bank (ECB) is responsible for monetary policy, fiscal policy is left to 13 individual governments and they do not always see eye to eye with each other, or with the ECB for that matter. Of the Big Three, Germany has once again taken the lead and is now growing faster than either France or Italy on the year. EMU fourth quarter GDP was up 0.9 percent and 3.3 percent when compared with the same quarter a year ago.

After a fallow growth period between 2001 and 2005, Germany once again became the EMU's Big Three growth leader in the second quarter of 2006 thanks in large part to soaring international trade combined with a revival in domestic demand. But progress has been made domestically with structural reforms especially in the labor market and unemployment has been falling steadily. The euro's strength weakened exports to non-European Union countries but did not affect intra-EU trade - that is trade between EU member countries. With over 60 percent of exports absorbed in intra-eurozone trade, the value of the euro affected 40 percent of exports. Germany has benefited from improved growth in other EU countries as a result. German GDP was up 0.9 percent on the quarter and up 3.7 percent on the year.

Even though France had been more successful in introducing structural reforms, the economy was lethargic in 2005 and most of 2006 thanks especially to faltering domestic demand. There is a good deal of political uncertainty in France as the populace awaits the outcome of the exceedingly fractious presidential election in April. In some of the campaign rhetoric, the ECB and the value of the euro have come in for their share of the blame for France's lackluster performance. GDP climbed 0.6 percent and 2.2 percent on the year in the fourth quarter.

Italy's economy stalled in 2003 and continues to struggle, although a turnaround appears to have begun in the fourth quarter of 2006. Italy has been particularly hard hit by Chinese exports, especially products that were formally the country's domain such as shoes. However, the economy has revived in the last two quarters of 2006 along with the rest of the EMU. In the fourth quarter, Italy's GDP was up 1.1 percent and 2.5 percent when compared with last year after climbing 0.3 percent and 1.6 percent respectively in the third.

UK's economy continues to bounce along as housing prices and consumer spending adjusts to higher Bank of England rates. Although it softened in 2004, the economy did not come close to weakening like its European neighbors. Though unemployment has crept up from historic lows, it is still quite low compared with the country's European counterparts. Inflation is troublesome and is above the Bank's inflation target of 2 percent by a substantial margin. The consumer price index, the Bank of England's inflation measure, was up 2.7 percent on the year in January 2007. Manufacturing continues to recover slowly from its malaise. Britain's fourth-quarter GDP was up 0.8 percent and 3 percent on the year.

The two graphs below show recent year over year GDP growth rates for the major industrialized economies. In the first graph are of the United States, Britain, the European Monetary Union and Japan. The second graph includes the EMU's three largest economies - Germany, France, Italy - plus Australia and Canada.

Asia and Australia thrive on exports
Higher interest rates combined with a record setting drought have cooled Australia's economy from its blistering 4 plus percent 2004 pace. The resource sector has offset easing elsewhere as it exports coal and iron to Asia's emerging markets. Domestic demand had been spurred on by consumer spending and a construction boom. Low mortgage rates boosted residential construction, and that in turn spilled over to more purchases of household furnishings and electrical appliances. The Reserve Bank of Australia has been increasing interest rates intermittently since November and December of 2003. Its most recent increase was in November 2006 when rates reached their current level of 6.25 percent. But this latest increase has not tamped growth or inflation as much as the RBA would like. Inflation remained above the Bank's inflation target range of 2 percent to 3 percent in the fourth quarter at 3.5 percent. Fourth quarter GDP was up 1 percent and 2.8 percent on the year.

After slowing in the second and third quarters, Japan's economic growth picked up again in the last quarter of 2006. The Bank of Japan is in the process of normalizing monetary policy after formally declaring that deflation is over and has increased its policy interest rate to 0.5 percent. But thanks in part to falling crude prices, the consumer price index has barely increased, and the GDP deflator continues to show declining prices. Earlier growth was solely the result of exports. But now domestic demand shows signs of stirring and banks have begun lending again. Financial sector strains, including the need to issue a large volume of public debt without pushing up interest rates, present formidable challenges. Recent economic data have been uneven with machine orders increasing but the consumer sector lagging. The current expansion is the longest in a half a century. Fourth quarter GDP was revised to a gain of 1.3 percent, 2.5 percent on the year and at an annualized rate of 5.5 percent.

Canada and U.S. continue on growth path
The Canadian economy continues to benefit, like Australia, from commodity exports. While Australia has benefited from Asian growth, Canada's best customer is the United States. Residential construction has slowed in response to interest rate increases by the Bank of Canada. The Bank has been faced with making policy for a growing dynamic resource sector in the West and a frail manufacturing sector in the East. The manufacturing sector has been hard hit by the relatively high value of the Canadian dollar. Consumer spending, which accounts for almost 60 percent of the economy, and business fixed investment, which includes spending on commercial construction as well as equipment and software, have both eased since the first quarter. They were up 0.8 percent and 1 percent in the fourth quarter and significantly lower than first quarter increases of 1.3 percent and 2.7 percent respectively. Overall fourth quarter GDP was up 0.4 percent on the quarter and 2.3 percent on the year.

The United States also grew at a slower pace in the second half of 2006 after a robust first half. The U.S. economy has been motoring along thanks to loose fiscal policies and despite Federal Reserve interest rate increases that have taken the target fed funds rate from 1 percent to its current 5.25 percent level. Although growth has improved elsewhere, exporting countries such as Japan and Germany continue to look to the U.S. as the main fount of growth. And U.S. consumers have done their part by maintaining demand for imported consumer goods, helping to send the merchandise deficit to all-time highs. Fourth quarter GDP growth edged up to a 0.6 percent increase when compared with the previous quarter and 3.1 percent when compared with the same quarter in 2005. On an annualized basis, GDP was up 2.2 percent.

Bottom line
Despite a year of increasing interest rates, growth continued to pick up in most of the countries followed here. But there are some questions going forward - can Germany and Japan improve domestic demand and can Japan keep deflation at bay. Assuming no exogenous events, growth is expected to pick up in the global economy during the first half of 2007. This should help the U.S. - increased growth abroad could mean more exports to Europe and Asia, relieving some of the onus of being the sole engine of worldwide growth. The important thing for Europe and Asia is that they continue to proceed with badly needed structural reforms despite their recoveries.

The Bank of Japan finally has started to normalize monetary policy, and the government needs to find a way to deal with its huge volume of fiscal debt. Although prices are rising in Japan, latent worries about deflation surface each time a weaker-than-expected economic data report is released. Europe needs to continue to reform labor rules to stimulate domestic demand and take pressure off its export sectors. And service sector reforms still await action. The U.S. still needs to find a way to finance its twin deficits so they are more manageable and less of a problem for foreign investors. At present, the deficits are being financed in a large part by Asian nations who are buying U.S. Treasuries with extra dollars earned from exports.