Sunday, June 29, 2003

France: Euro Strength Leaves Its Footprint

Morgan Stanley's AnnaMaria Grimaldi and Eric Chaney look at the results of the latest French INSEE survey, and admit their surprise, things appear to be worse than expected and downside deflation risks growing.

In contrast with the German IFO and the Italian ISAE indicators, the INSEE index took a dive, instead of improving slightly as had been expected. At 90, the synthetic indicator is now almost as low as it was in October 2001 (89) and 10 points lower than its spring 2002 high. The French manufacturing sector is experiencing its own double dip. Is it a consequence of the wave of social unrest related to the pension reform (which, by the way, is making good progress in the national Assembly)? The INSEE survey does not confirm this hypothesis. For instance, the non-weighed diffusion index ("general" assessment) was stable at -32, the same level as in January-February. Also, opinion on recent output improved, dismissing fears that transportation strikes had a very negative effect on production. So where was the catch?

It was on the demand side, indeed, and especially the overseas one. Opinion on orders declined to a level not seen since June 1996, during this "mini recession" that followed the forced fiscal convergence in the euro-area-to-be, ahead of EMU. More importantly, domestic demand was not the main culprit, since foreign orders dropped 9 points, to their lowest level since the 1993 recession, versus 3 points for total orders. Beyond the strength of the euro, the most likely explanation for this setback is the weakness of domestic demand in Europe, in particular in Germany, the biggest export market for France.

However, the (passed?) strength of the euro left a clear footprint on manufacturers assessment. Personal price expectations dropped to -18, from -2 in January, underlining the negative impact of currency moves on pricing power. We are now close to the historical low reached in December 1998 (-23). Notice that Brent crude quoted 9.9 $/bbl then, whereas it is close to 28$ today. This time, the deflation threat is more serious.

Coming on top of negative news from Belgium and the Netherlands, and mixed news from Italy and Germany, the INSEE survey does not make things any better. Our Euroland manufacturing model is now pricing -0.9%Q in Q2 (it was at -0.7% before the INSEE survey), still consistent with a flat GDP reading. Looking forward, the full set of June surveys is providing a preview of what could be the third quarter in the real economy: Our manufacturing model is hinting to another contraction (-0.6%Q), which our GDP model turns into a meagre 0.2%Q GDP growth. At this stage, these estimates are founded on expectations only and are still very fragile. However, the diagnosis from the model is broadly consistent with our macro scenario: no significant pickup is expected in Europe before the fourth quarter, in the best case.
Source: Morgan Stanley Global Economic Forum

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