Friday, December 28, 2007

Eurozone Retail Sales, Manufacturing PMIs and French Q3 2007 Growth

Evidence of the growing slowdown in the Eurozone economies continues to show up across the board. German retail sales, for example, fell for the third consecutive month in December according to the Bloomberg purchasing managers retail sales index released at the end of December.The index came in at a seasonally adjusted value of 44, compared with 43.6 in November. A reading below 50 indicates contraction. Retail sales across the entire 13 nations euro bloc also declined in December.

German households have evidently been reining-in spending recently after rising oil and food prices pushed inflation to the highest in 12 years last month. Economic growth in Germany is slowing as the global expansion ebbs and the euro's rise to a record crimps exports.

Germany's IWH institute, which helps provide twice-yearly reports for the government, on Dec. 20 cut its growth forecast for 2008 to 1.7 percent from 2.5 percent. In 2007, the economy probably expanded 2.5 percent, Halle-based IWH said.

German consumer prices, measured using a harmonized European Union method, rose 3.3 percent in November from a year ago. That's the most since the data were first compiled in January 1996.

Retailers' gross margins showed the sharpest decline since January 2006, with a gauge falling to 39.4 from 42.5 in November, according to NTC economics who prepare the retail sales index. The indicator measuring the average prices of goods purchased for resale increased to 70.4 from 69.9 in November.

In December, retailers also failed to meet their sales targets, with a gauge which measures this rising slightly to 38.5 from 37.2 in November according to the report. Companies also expect sales to miss projections in early 2008. An indicator measuring future sales dropped to the lowest in a year.

``Consumer confidence remained low despite increased marketing efforts by retailers,'' NTC said in its analysis. ``Worries about a wider economic slowdown and uncertainty in the financial markets heading into the New Year were highlighted.''

In fact while sales, as I said, fell across the zone, retailers in Germany suffered the biggest decline, but sales also dropped in France for a third month, putting the index at 49.1, while a Italian sales dropped to 44.7 from 45.3.

Euro zone purchasing managers surveys for the manufacturing sector also tend to confirm the idea that the economy of most member states has slowed is likely to have slowed in the fourth quarter despite what seem to be pockets of resistance in some countries.

The purchasing managers index for the euro zone manufacturing sector eased to a final 52.6 in December from 52.8 in November. The December figure was revised up slightly from the provisional reading of 52.5. The manufacturing PMI for the whole zone has managed to remain above the October low of 51.5, but the December reading is still the second weakest figure since Aug 2005.The German PMI eased slightly but held up better than expected, slipping to 53.6 from 53.7 against market expectations for a decline to 53.2.

And Yet France Resists!

However not all the news coming out of France in recent days has been negative. In the third quarter of 2007 French Gross Domestic Product (GDP) grew by 0.8% according to revised estimates from the French statistics office Insee published this week. One of the strong points in this data was the performance of domestic consumption, with household expenditure rising by 0.8% ( following +0.6% in the second quarter of 2007), and thus contributing +0.4 point to GDP growth. General government expenditure slowed from a 0.5% y-o-y rate in Q2 to 0.4% and contributed +0.1 point to Q3 GDP growth.

Total Gross Fixed Capital Formation (GFCF) grew at an annual 0.6% (+0.4% in the previous quarter). The GFCF of households grew by 0.6%. In total GFCF contributed +0.2 point to GDP growth. Exports growth increased (+1.5% after +0.7% in the previous quarter), whereas imports grew more slowly, by 1.0% (after 1.8% growth in Q2), so that net foreign trade contributed +0.1 point to GDP growth (after being a -0.3 points drag in Q2). Inventory changes did not contribute to GDP growth (after +0.1 point in the preceding quarter).

Euro zone purchasing managers surveys for the manufacturing sector also tend to confirm the idea that the economy of most member states has slowed is likely to have slowed in the fourth quarter despite what seem to be pockets of resistance in some countries.

The purchasing managers index for the euro zone manufacturing sector eased to a final 52.6 in December from 52.8 in November. The December figure was revised up slightly from the provisional reading of 52.5. The manufacturing PMI for the whole zone has managed to remain above the October low of 51.5, but the December reading is still the second weakest figure since Aug 2005.

As suggested above, country level PMI surveys are giving the impression that national growth disparities within the euro area may be widening. France, for example, continues to resist the general downward trend in manufacturing with the French manufacturing PMI staging a small rally and climbing to 53.8 in December from 52.5 in November.

Nonetheless Q4 may not be so positive as the third quarter was. As already noted, retail sales dropped in France in Novermber for the third month in succession according to the PMI, with the December index oming in at 49.1,

However consumer confidence in France unexpectedly dropped to a 19-month low in December in France. Consumer sentiment fell to minus 29 from minus 28 in November,according to Insee, the Paris-based national statistics office. The December reading is the lowest since May 2006.

But Italy Goes From Bad to Worse

Italian retail sales declined for a 10th successive month in December as a bleaker economic outlook damped consumer demand during what should have been the busiest shopping period of the year. The seasonally adjusted purchasing managers index of retail sales dropped to 44.7 from 45.3 in November. The reading has now been below 50, the level that signals a contraction in sales, since February. Even record low unemployment of 7.2 percent has failed to spur purchases, prompting retailers to expect lower sales next month.

The Italian manufacturing PMI also fell more than expected, declining to 50.7 from 51.3 (a level at which industry is just expanding, but only just), compared with expectations for a decline to 51.0. This meant the index was at its lowest level for more than two years.

And the Spanish manufacturing PMI fell to 49.5 from 50.7, dropping below the critical 50 dividing line between expansion and contraction (see this post for more details).

And while the German PMI showed some resistance in December, it has fallen a long way in recent months and has now gone below the French index for the first time since Sept 2005. The softening of overall euro zone growth is likely to prompt the European Central Bank to keep its main interest rate unchanged at 4.00 pct for some time to come, but inflation worries mean that interest rate reductions are not likely to come soon.

Tuesday, December 25, 2007

Merry Xmas and A Happy New Year

Well, a Merry Xmas and a Happy New Year to all my readers. Thank you for taking the time and trouble to pass-by. This blog will now - failing major and surprising new developments in the global economy - be offline till the end of the first week in January, or till after the festival of Los Reyes Magos in Spain (for those of you who know what this is all about). Come to think of it, maybe this is just what our ever hopeful central bankers are in need of even as I write - some surprise presents from the three wise men - but I fear that this year if these worthy gentlemen do somehow show at the next G7 meet, the star in the east which draws them will not be the one described in the traditional texts, but in all likelihood the rising star of India.

Credit crunch, did someone use the expression credit crunch?

Monday, December 24, 2007

German GFK Consumer Confidence January 2008

German consumer confidence unexpectedly rebounded ever so slightly from what had been the lowest level in almost two years at the end of December as shoppers appear to have become slighly more willing to spend as the holiday season approaches. GfK AG's index for January, based on a survey of about 2,000 people, rose to 4.5 from a revised 4.4 in December, the Nuremberg-based market-research company said in a statement at the end of last week.This "snippet" of news lead to all sorts of speculation in the financial and business press, but I think we need to be very careful indeed here. There is such a thing as clutching at straws, and we all have a tendency to see what we want to see, to emphasise the good news, and play down the bad, to hold to what conforms to how we see the world and to discard the world. I do it, you do it, and of course the financial and business media do it bigtime.

So if you come to look at the chart below, what stands out is not the difference between December and January, but how similar they are with each other when compared with, say, October or September. Consumer confidence in Germany is plumming the lows, and at the moment it is staying there. Of course some sort of rebound is only to be expected after the beating which German domestic consumption has taken across 2007. Again let's look at the chart:

2007 has been a baaad year, and there's no mystery about why. VAT was raised by 3 percentage points on the 1st January, giving the German consumer a hefty hit where it hurts, in the pocket. So clearly, after things being so bad, they have to get just a little better (or at least so the theory would go, and here's hoping). All I would say is that on the Gfk reading it is way to soon to start declaring that this slight rebound has taken happened (don't hold out hope for a massive recovery, look at the longer term trend). And this situation is only confirmed when we come to look at the index sub components.

The indicator measuring households' willingness to spend rose to minus 10.7 from minus 21.8 in the previous month, indicating a slight improvement in the climate as we entered the xmas season, but there is little remarkable in that, indeed it would have been remarkable if things had not recovered slightly. On the other hand consumers income expectations fell to minus 1.7 from zero and shoppers also became less optimistic about the general economic outlook, with this indicator declining to 23.6 from 24.1.

According to Klaus Wuebbenhorst, chief executive officer at GfK, today's report is "good news, giving reason for optimism for 2008"...."Consumers are more willing to buy more expensive products, which is good news for Christmas sales." Well, as I say, there are opinions here to suit all tastes, so from here on in its up to you to make up your own mind what the reading actually means.

Friday, December 21, 2007

Italian Business Confidence December 2007

Italian business confidence declined to a two-year low in December after a strike by lorry driver disrupted production and as manufacturers brace themselves for the likelihood of slower growth. The Isae Institute's business confidence index fell to 91.8 from a revised 92.1 in November, the Rome-based research center reported today. That is the lowest since December 2005, when the index reached 91.5.

A sub-index measuring manufacturers' expectations for production in the next three months fell to 11, the lowest since July 2005.

``The short-term production outlook probably is being hurt by the declining forecasts regarding the international growth cycle,'' Isae said.

The Organization for Economic Cooperation and Development predicted on Dec. 6 that eurozone growth will slow to 1.9 percent next year from 2.6 percent in 2007. The OECD has also cut its forecast for 2008 U.S. growth to 2 percent from 2.5 percent. Non of these predictions may turn out to be accurate, but they are all pointing in the same direction.

Growth in Italy, which is Europe's fourth-biggest economy, has lagged behind the Eurozone average for the last 11 years, and will continue to do so for at least the next two, according to the European Commission in a Nov. 9 forecast.

Confindustria, Italy's largest employers' lobby, on Dec. 14 also cut its forecast for the Italy's economic growth next year to 1 percent, almost half the rate predicted for 2007.

Thursday, December 20, 2007

Italy Consumer Confidence December 2007

Italian consumer confidence fell to a four-month low in December as signs that economic growth is slowing prompted households to cut back on spending. The Rome-based Isae Institute's index, based on a survey of 2,000 families, fell to 107 from 107.6 last month.

A 48 percent jump in oil prices this year is raising household energy costs while a lorry driver's strike has disrupted this months delivery of basic foods such as milk, boosting grocery bills. Higher credit costs sparked by rising mortgage defaults in the U.S. are also starting to weigh on consumer optimism in what is still Europe's fourth-largest economy.

The biggest concern expressed by consumers concerned the outlook for the economy. Optimism about the general economic situation fell to 89.6 from 91 with confidence about future prospects dropping to 112.5 from 113.7, Isae said.

Consumer spending has been consistently weak in Italy in recent years. Retail sales declined for a ninth month in November, accordig to the Bloomberg sponsored purchasing managers index showed.

The pace of household spending slowed to 0.2 percent in the third quarter, compared with growth of 0.6 percent in the previous quarter, according to the ISTAT National Accounts data.

Italian economic growth has lagged behind that of most other counties in the eurozone for more than a decade now (the other weak party is Germany in this regard). The Italian government cut its growth forecast (29 Sept) for next year to 1.5 percent from an earlier 1.9 percent forecast. The Italian government is still more optimistic than the European Commission, however, since the latter estimate Italy's 2008 growth rate at 1.4 percent, and there are plenty of downside risks all round here.

Wednesday, December 19, 2007

Germany IFO Index December 2007

Well, this is almost getting boring at this point, as a certain predictability and inevitability enters into all the data, and especially the sentiment indexes, which are down, down, and down again. Today it is the turn of IFO Institute's German business confidence index to fall to its lowest level in almost two years in December as rising credit costs, higher oil prices and the euro's appreciation threatened to curb growth in Europe's largest economy.

The Munich-based Ifo research institute's business climate index, which surveys 7,000 executives, declined to 103 from 104.2 in November.

"The risks to price stability over the medium term are clearly on the upside" Jeab Claude Trichet told the European Parliament's economic and monetary affairs committee in Brussels yesterday, and, he might have added, the risks on the economic performance and growth front are all pointing to the downside. But still, a mandate is a mandate I suppose. Now how did the poem go? Ah yes, half a point, half a point, half a point upward, into the valley of death rode the 600.

Friday, December 14, 2007

Eurozone Inflation November 2007

European inflation accelerated more than initially estimated in November, to the fastest pace since May 2001, making it very hard for the ECB to justify moving towards a cut in interest rates even as economic growth slows across the zone. Now normally neither Claus or I pay special attention to the 13 nation eurozone average inflation rate (the so called MUICP), since this aggregate figure masks as much as it reveals, given that in the case of the eurozone the differences which exist between countries are always very important. However since this data point is now destined to play such an important role in ECB history, it is worth making an exception this time round.

The MUICP inflation rate in the 13-nation euro area in fact rose to 3.1 percent in November from 2.6 percent in October, according to Eurostat data released today. That exceeded by one tenth of a percentage point an initial 3 percent flash estimate published on Nov. 30.

The European Central Bank has been unable to follow its counterparts in the U.S., the U.K. and Canada in reducing borrowing costs, since it has rather boxed itself in with its discourse that surging commodity prices and declining unemployment will trigger an inflationary spiral. ECB President Jean-Claude Trichet even went so far as to say on Dec. 6 that some governing council members actually favored raising interest rates. Commodity (and especially food) prices certainly are a problem, but the unemployment situation is more tricky than it seems, since noone has yet gone to the trouble of re-calibrating the standard NAIRU charts to take into account the sort of ageing labour force employment dynamics we have been seeing in Italy, Germany and Japan, where in each case the drop in unemployment has NOT been accompanied by a surge in wage inflation. The implications of all this still, as I say, await calibration and assessment, and I think that the central banks are treading on dangerous ground if the take strong policy decisions without carrying out the necessary studies.

In Germany, as noted in my last post, inflation picked up in November to 3.3 percent, the fastest pace in 12 years. What isn't clear at this point is what proportion of this acceleration in German inflation is a result of the base effect of January, when, it will be remembered, prices of most retailed goods rose by 3% due to a government VAT hike. So whose expectations exactly are we trying to steer here? Government ones that they should not pass the funding cost of rising elderly dependency ratios onto domestic consumers who are already weakened by the impact on wages and consumption of the rising median age? I both hope so, and hope not. I hope so, in the sense that I hope noone will now repeat this very ill advised move on the part of the German government, and I hope not in the sense that it would be stupid to try and make German citizens pay in the form of a longer and deeper than necessary recession for the errors of their government. Let's learn the lesson and turn the page here.

More worryingly, the Spanish rate surged to 4.1 percent from 3.6 percent. This is quite notable, since, as can be seen in the chart below, Spain inflation had been slowing under the impact of the steady unwind in the property market that the ECB's rate tightening policy had been producing, and, as I show in this post here, all the signs now are that the slowdown in the Spanish economy has been accelerated by the sub prime turmoil, and is now developing pretty quickly. The problem is that Spain, even despite this short term surge, definitely needs monetary loosening, and as soon as possible. Nearly 80% of Spain's very heavily mortgaged house-owning population have variable rate mortgages based on Mibor or Euribor, and these are all set to rise significantly in the coming months, even as the Spanish economy slows. And again, if, as now seems quite probable, the two "usual suspect" economies in the eurozone (Germany and Italy) fall into recession next year, they will be joined this time round by Spain, which will only leave us with France, to be holding the fort as it were, in the absence of the other three.

Greece, while a much more minor player in this particular game, is really a very similar situation to Spain, given the extent of the housing boom there in the past, and given the endemic tendency to higher than eurozone average inflation. The Greek economy is now surely slowing, and probably significantly so.

Italy is a rather case, since the Italian economy is slowing by the day, and may well be headed into recession in 2008, and inflation - despite that ever tightening labour market - has failed to surge to the extent that it has in other parts of the eurozone, remaining down at 2.6%.

Finally we could just take a quick look at Slovenia, the zone's most recent member, and the only country in the EU10 to have joined the common currency so far. Inflation in Slovenia accelerated to 5.9% in November. I have done a longer country study of Slovenia (here) but all of this does make you wonder just whether Slovenia is headed to some extent off where the rest of the EU10 seem to be going, and if it is at least we ought to ask ourselves the question: is being a member of the eurozone a help or a hindrance in this situation?

Does One Size Really Fit All?

ECB staff has forecast that inflation will accelerate to an average of 2.5 percent in 2008 from 2.1 percent this year, according to projections published on Dec. 6. Trichet noted at the time that these forecasts assume no ``second-round effects,'' such as wage increases. Council members Juergen Stark and Erkki Liikanen have both said they disagreed with the forecasts, calling them too optimistic. So far, however there has been little sign of second-round effects. If you look at the Eurostat data you find that eurozone labor-cost growth has been pretty "steady" at 0.6 percent for almost two years. The bigger danger in the eurozone at the present time is that a number of countries fall into a deeper and longer recession that really need be the case. But to adequately handle the needs of each country in critical and complex situations like the one we have on our hands right now we need a much more sensitive type of montetary policy. Unfortunately this is simply a luxury we no longer dispose of.

Thursday, December 13, 2007

ZEW Investor Confidence Index December 2007

Investor confidence in Germany dropped more than economists forecast in December, reaching the lowest level in almost 15 years, as rising credit costs dimmed the outlook for economic growth. The Mannheim-based ZEW Center for European Economic Research said its index of investor and analyst expectations fell to minus 37.2, the lowest since January 1993, from minus 32.5 last month.

InterBank Rates

The cost of borrowing euros for three months rose to the highest since December 2000 today as banks seem to be hoarding cash to cover their commitments over year-end. The euro interbank offered rate, the amount banks charge each other for such loans, rose 3 base points to 4.93 percent, the European Banking Federation said today. That's 93 basis points more than the European Central Bank's benchmark rate. If we look at the latest available data from the British Banking Association we will see that the three month euro Libor rate turned up once again in mid November, and has not stopped rising since.

It is important to realise here that this movement in the 3 month libor that we see since the start of August has taken place without any change in interest rates at the ECB. But these rates will affect all those borrowers who are on variable interest rates tied to Euribor (or Mibor) and, for example these are nearly 80% of mortgage holders in Spain, so a sharp tightening is now taking place, even as general economic conditions deteriorate.

Growth in Germany is expected by virtually everybody to slow next year, although no-one really knows by how much, and downside risks abound. A drop to 1.7 percent next year was forecast by the RWI economics group last week, but even this may be on the optimistic side.

German Exports

Meanwhile German exports unexpectedly rose in October, pushing the trade surplus to a record.

Still, the euro's 11 percent advance against the dollar this year is making German exports less competitive abroad, adding to concerns. Exports were the driving force behind last year's 2.9 percent economic expansion, which was the fastest in six years. And if we come to look at the evolution of the year on year growth rates in exports (which is the key data point I would argue), we can see that the trend is now definitely down, and indeed that the export component in this present expansion probably peaked sometime in the last quarter of last year.

So what can we expect from this. Well it may be worth reminding ourselves about what happened last time round, ie last time the acceleration in the Y-o-Y growth rates in German exports effectively stalled. That was back in early 2000, as we can see from the chart below. And what happened at that time? Well the fed was easing as the US entered recession, and the euro was to some extent rising, both of which put a strong break on German exports. So it isn't the rise in the currency alone that matters, you have to think about the whole environment which produces it. Why your currency is rising, while someone else's is falling. And of course, in German export terms, after the rise comes the fall. This is the cost of not being able to depend on your own internal demand, you have to depend on someone else's demand.

As we can see once the rate of increase in annual exports entered real decline, GDP was not far behind, and off Germany went into recession. So this time round the same thing may well happen, and domestic demand may well not offset any fall-off in foreign sales as oil-driven inflation and rising borrowing costs steadily sap German consumer and corporate spending power. Last month, consumer prices rose 3.3 percent from a year ago, the most since records began in 1996. The price of oil has gained 44 percent this year. At the same time German wages, as is well known have had only very weak increases in recent years.

Germany Economy, What Price the VAT Effect Now!

I don't think there is much to say about the chart below. I created it as I was going through the detailed data for Q3 2007 German GDP. Some of the things you were taught in Econ 101 do turn out to be more or less valid, despite what a whole battery of people who should have known better (from the FT to the Economist) were telling you not so long ago. You can't raise prices without some effect on demand. And when you tell people you are going to raise them in advance, then you should expect them to stock up as best they can. So we get a big spike at the end of 2006, and then 3 quarters of year on year negative consumption growth. I'm not sure after this experience people will be piling ageing society costs onto already fragile domestic consumption again. I do hope they are looking at this data in Japan.

Inflation on the Rise

And just to make things really complicated for the ECB German inflation accelerated in November to the fastest pace in 12 years, led by surging oil and food costs.

onsumer prices, measured using a harmonized European Union method, rose 3.3 percent from a year ago after increasing 2.7 percent in October, the Federal Statistics Office in Wiesbaden said today, confirming a preliminary estimate published Nov. 27. That's the fastest inflation measured since harmonized data for Germany started being collated in January 1996. In the month, prices rose 0.5 percent.

An 84 percent surge in oil prices since mid-January is driving up inflation even as the euro's ascent to a record against the dollar makes imports cheaper. While the European Central Bank on Dec. 6 left its key rate at 4 percent, President Jean-Claude Trichet threatened to raise borrowing costs if workers win bigger pay increases to compensate for higher costs. While the wage response to the price pressure is likely to be moderate, the inflation squeeze following on the back of the VAT hike is likely to weaken an already weak domestic consumption even further.

As we can see in the chart below - which gives a breakdown in Q3 GDP component contributions to growth, the heavy lifting was carried out by exports, and these were followed by machinery and equipment investment (which to some extent is related to export needs). So if external conditions deteriorate, even slightly - which all the forecasts suggest they will for 2008 - then Germany will have increasing difficulty maintaining the pace of the export expansion. Remember, for Germany to fall into recession we don't need to see negative export growth, just a substantial reduction in the rate of increase.

and just to end up where we started, here is a chart of the contributions of private domestic consumption to GDP growth in recent quarters. As can be seen, during the three last quarters (following the VAT anticipation spurt) consumption has acted as a drag on growth. With inflation now biting into consumers pockets, and monetary conditions effectively tightening, this position is more than likely going to deteriorate.

Monday, December 10, 2007

Italian Industrial Output October 2007

Italian industrial production declined in October for a second month as the euro's gains against the dollar continued to put pressure on export competitiveness. Production fell 0.3 percent from September, and 1.5% year on year, according to the national statistics institute (Istat) today.

The economic outlook for what is Europe's fourth-biggest economy is dimming by the day, as imports continued to outpace exports in the third quarter and as the pace of consumer spending growth slackened in Q3 2007.

Italian production of consumer goods dropped 0.1 percent in October, according to the detailed breakdown of today's data. Manufacturing of non-durable goods such as clothing fell 0.1 percent. Durable goods, which include washing machines and refrigerators, declined 0.2 percent.

Friday, December 07, 2007

Italy Q3 2007 GDP Breakdown

Well, today, courtesy of ISTAT, we got the breakdown on Italy's Third quarter GDP.

As we can see, quarter on quarter growth was up slightly from Q2, although the underlying trend is obviously down.

So the question is, what is dragging things down and what is pulling things up? Well one of the big downside issues is definitely the surge in imports.

And in Italy's case I think we know the culprit: the high value of the euro. Faced with this surge in the relative value of the euro Italian exporters simply can't hack it, even in the eurozone, or among the EU10 effective peggers. The strength of ex-zone competition in some of Italy's key export areas is just too strong. In fact exports did not have a bad quarter, since they rose 0,9% q-o-q, but this was completely dwarfed by the 2.4% q-o-q surge in imports.

Household spending, which makes up two-thirds of Italy's economy, grew slightly (by 0.2 percent) but was down when compared with the 0.5 percent rise achieved in the second quarter, or the 0.7% one in the first quarter.

Be all this as it may, Italian domestic consumption, despite the increase in the working population via immigration and the low levels of unemployment registered recently, remains very weak.

As can be seen, Italian household consumption has been congenitally weak over a number of years now, and the only real bright spot has been at the end of 2006 and the begining of 2007. This took me by surprise I must admit, and mirrors what we have also seen in Germany and Japan, and it was undoubtedly this phenomenon that lead to all the speculation about uncoupling, but now, as we are seeing, things are returning pretty much to where we left off a couple of years back, which I think is important.

Due to the similarity in the structural components here between Germany, Japan and Italy (with Italy's weaker export performance being the only real distinguishing feature) Claus Vistesen and I are arguing that all of this is age related, and so just to close on a novel note, here are the comparative median ages for Germany, Italy and Japan, for 1990 to 2020 (click on image for slightly better viewing). This is definitely one area where all 3 are world leaders.

Thursday, December 06, 2007

Eurozone Blues and ECB Dilemmas

Well Claus is currently up to his eyes in exam preparations, that and recovering from his incredible tour-de-force yesterday, so I will take over the eurozone tiller momentarily, and give a brief lead-in to today's interest rate decision over at the ECB. (Update: since this post was published the ECB have announced - as expected - that they are keeping rates on hold. Euro values are not taking the news well - or perhaps they are taking them too well, depending on your view - since Trichet has said that some board members actually wanted to raise, but for the rest, I think this post stands up fine as is).

So, if it is the eurozone we are talking about, then why not start with Germany? And what better place to start than with German retail sales, which fell fell at the fastest rate in more than three years in November according to the Bloomberg purchasing managers index, which fell to a seasonally adjusted 43.6 from 48.6 in October.

Any reading below 50 on this index indicates contraction, thus retail sales have only managed an increase - as measured by this index - in four months this year. Retail sales across the entire 13-nation euro region also fell in November according to eurostat data released yesterday, dropping by 0.7 per cent from October to a level which is just 0.2 per cent above the November 2006 level. Of course this average hides considerable variance, with the weakest performance coming from Germany, Italy and Belgium.

Also worthy of note is the performance of retail sales in Spain (the zones 4th largest economy) since strong growth in Spain has previously offset weaknesses in Germany and Italy at critical junctures. But this time it will be different, since Spanish retail sales have fallen in both October and November, and while the year on year readings are still in positive territory, they will not remain there for long since the earlier strong readings will eventually drop out of the data.

And since the spring the story in both services and manufacturing has been one of one long and sustained declined, as the data from the monthly Bloomberg/NTC Purchasing Manager Indexes reveal.

Meanwhile the consumer confidence index prepared by the Instituto de Credito Oficial continues to plummet the depths, registering at 76.1 in November a historic low for the third consecutive month.

This drop in confidence is also reflected in the data for new mortgages issued (latest data still only September unfortunately), where the slowdown is clear if you compare the numbers for 2007 with those for 2006 (and especially since the spring, although my feeling is that when we get numbers for October and November we will see the slowdown accelerating, as buildings contracted in 2006 reach competion. Of course we should remember that those buildings and flats sold on the basis of architects plans in June and July - ie prior to the August sub-prime "bust" - will still be giving work until next summer, even if the would be purchasers may be increasingly looking for an "escape clause" as property prices steadily decline).

If we turn to the employment sub-component of the Spanish index we will see that the outlook has changed dramatically in the last three months.

and the underlying situation again becomes clear if we look at the unemployment numbers, where a comparison between 2006 and 2007 is again revealing. We can see that in the early months of this year the employment situation was up over 2006. Then the situation turned (around July), and since then it is "down hill all the way" unfortunately.

Italy is Creaking At the Door

Italy of course isn't in much better state, and Italian retail sales declined for the ninth month this year in November as the bleaker economic outlook continued to damp consumer demand, according to the Bloomberg retail purchasing managers index monthly survey. The reading has been below 50, the level that signals a contraction in sales, every month except January and February. And at 50.6 (January) and 50.4 (February) sales were barely increasing (on a seasonally adjusted basis) even then.

Of course Italy has long been regarded as the "sick man of Europe" so this result is not too surprising. Business confidence is non-too strong either, and the ISAE Italian business confidence index declined in November to the lowest level in almost two years as the euro's gains have continued to acting as a curb on exports. The Isae Institute's business confidence index fell to 92.2 from a revised 92.8 in October, the lowest reading since December 2005.

In addition the Italian services sector purchasing managers index fell to a seasonally adjusted 50.8 in November from 55.3 in October. So Italian services are still ekeing out a small expansion, but they are creaking.

While the Italian manufacturing sector purchasing managers' index remained at a seasonally adjusted 51.3 in November the same level as registered in October. So in both cases, the expansion continues, but only just, which is the same thing as saying that- since the negative exports balance is now a net drain on GDP growth, and government spending should be under a tight rein to bring down the debt - the the Italian economy may now be near to a contraction phase.

German Employment

Returning now to take another look at Germany, what is most curious is how German consumers are reining-in spending and becoming ever more pessimistic even as the jobs market remains reasonably buoyant. Earlier last the week we learnt that German consumer confidence, as measured by the GfK AG's index had fallen to the lowest in almost two years.

Business confidence is not much better, with the IFO index - which managed a very modest recovery this month from last month's low - in very negative sentiment mood (and the ZEW index isn't any better).

Meantime German unemployment declined for a 22nd straight month in November, falling to the lowest level in more than 14 years (using ILO methodology), as companies took on more workers to meet increased demand. The adjusted number of people out of work fell by 53,000, according to the Federal Labor Agency in Nuremberg. The jobless rate, adjusted for seasonal swings, slid to 8.6 percent in November, the lowest since April 1993, from 8.7 percent in October.

In fact the total, unadjusted number of unemployed is the lowest for the month of November since 1992, when it was 2.97 million, according to Labor Minister Olaf Scholz. In addition the number of those employed continues to rise.

Also the number of those paying social security contributions continues its rise:

which is again worthy of note, since for some years the absolute number was falling:

So looking at these numbers, you might wonder what all the pessimism is about. Well the problem basically revolves around why increases in German wages and salaries have, despite this exceedingly positive general situation, remained generally weak.

What is notable about the above chart is the way in which the tightening labour market has not produced any substantial upward pressure on wages. Of course, one version of the story would tell us that this is because the German workers have been behaving like very good boys and girls. But is the more too all of this we might like to ask ourselves, especially since all of this is more or less a repeat performance of what has been happening in Japan.

And of course the weak earnings situation is passed on to consumption, with the consequences we can see in the chart below, which if for the quarterly development of private consumption in Germany since the start of 2005. No economic locomotive to be seen there, I fear. And before you leave the chart do note just one more time that spike in consumption in the last quarter of 2007. That's the VAT effect, you know, the one everyone tried to tell us didn't exist. Well it did, and just look what happened next to German consumption after the 3% hike. Relative prices, like relative exchange rates, do of course matter, and anyone who tries to tell you otherwise missed something in their basic economics course, I think.

Unfortunately one detail we don't have relates to the role of part-time employment in these numbers. I have been looking in detail at the Japan data, and there we do have this breakdown, and it is clear that the growing disconnect whereby we have significant GDP and employment growth by comparatively weak earnings and consumption performance may have something to do with this, and with the skill composition of the work being undertaken. Of course here I would see an age related dimension, but I guess for some that would be quite a tendentious point. Nonetheless we do have data from the recent past about the share of part time employment in total employment in Germany, and as we can see it has been steadily rising.

Be all this as it may, it seems that the path of Jean Claude Trichet will not be blocked, and that our stalwart central bank president - like the ubiquitous Ms Thatcher before him - is not for turning. This gentleman is not going to let himself be brow-beaten by mere fact.

Trichet in fact once more emerged from his un-announced early within-cloister retirement from the high-media-profile stage yesterday to give a talk in Berlin (in preparation, one imagines, for his ECB performance today) where he singled out Finnish nurses and German postal workers for particular criticism, holding they not taking sufficient account of their social responsibilities. What he means is, of course, that inflation is putting the ECB in a very clear double bind when it comes to taking a decision on interest rates.

But wages, as we have seen are not the pricipal issue here, at least in the German case (and the Finnish one is not that much different). The real culprits in the eurozone inflation surge - the last flash estimate from Eurostat put the eurozone average HICP rate at around 3% for November - are energy and food prices, and this inflation has more to do with global structural factors than it ever does with minimum wages in the eurozone (ie it is a result of the fact that the BRIC economies etc are driving the growth, and their rates of energy consumption are rising rapidly, while their population spends a higher part of their rapidly rising income levels on food products - maybe 25% of the extra income - than is the case in the developed economies).

Other explanations for the pessimism to be found in Germany (ie beyond the employment and wages data), of course, abound. Two prime candidates, oil and food price induced inflation and the rising euro tend to head the list. The euro, which rose to a record $1.4967 on Nov. 23 before dropping back slightly, has gained more than 12 percent against the US dollar so far this year and is trading at around $1.4673 as I write. Crude oil rose to a record $99.29 on Nov. 21 and was trading at $89.42 in electronic tradiong on the New York Mercantile Exchange earlier today.

The rising euro may well have an impact on Germany's export performance, while oil prices influence inflation, and through this consumer purchasing power. In fact inflation jumped in Germany in November to 3.3 percent according to the EU harmonised index, and this is the highest level registered in Germany since records began in 1996.

To Cut or Not to Cut?

The European Central Bank, which has raised the benchmark interest rate eight times since the end of 2005 as part of a "normalisation" and anti-inflation process, meets today to decide on interest rate policy . So far the bank has been buying time by arguing we still cannot adequately judge the impact of the financial turbulence spin-off from the U.S. housing slump and in exercising this caution they are almost certainly right. As Claus indicates in this post, there are indeed tough times ahead at the ECB.

And indeed there are. Only yesterday the Italian Vice Minister for the Economy Vincenzo Visco was informing a parliamentary panel that "The economic situation and world markets are very uncertain and present risks. It is expected that the Federal Reserve will cut interest rates and it would be suicide if the ECB didn't do the same thing for the euro zone." And it is not only the politicians this time round, ECB council members Christian Noyer and Jose Manuel Gonzalez-Paramo have been indicating that they are prepared to start talking interest rate reductions in a not very distant future. Noyer is saying that there has to be a "question mark" over whether or not Europe can dodge the fallout from the U.S. sub-prime generated turmoil (and see this post for an examination of the extent of the credit shock in the European banking system), while Gonzelez-Paramo rejected the idea that cutting rates would amount to a bailout of investors who lost money on bad bets. Central banks are not encouraging risk taking if they lower borrowing costs "when financial turbulences develop into a fully fledged crisis and eventually affect growth prospects" he stated at a conference in Milan earlier this week. So while we may well see a stand firm "on hold" posture on rates today, a change in the air cannot be far away now.

Even on the euro front "the times they are a changin", and rapidly rapidly, with even German Finance Minister Peer Steinbrueck - who as recently as Nov. 27 was expressing his confidence that Germany had "become much more resilient to negative economic impetus" and was going through a "robust recovery" is now suggesting that what we have is "a disorderly adjustment and unwinding."

In fact German leaders generally are now expressing a mounting unease over the euro's rise against the dollar and other currencies , and especially as survival warnings from European planemaker Airbus ring through their ears.

And remember, the weaker dollar can help American exporters at a time when the U.S. economy is suffering from a housing slump, trouble in mortgage markets and a going-global credit crunch "Exports are a huge bright spot in the economy ... and a source of strength going forward," Janet Yellen, president of the Federal Reserve Bank of San Francisco, is quoted as having said on Monday. As I argue in this post, the longer term problems in the US economy aren't anything like what they are currently being made out to be.

Of course the euro is now more than 20 percent over its dollar value two years ago and has been hitting record peaks recently against the yen, while China's currency has lost ground to the euro even while it has gained it against the dollar. Yet despite this, the trade-weighted rise in the euro this year has been limited to just 4 percent.

But this is just the point, what we need to ask ourselves is where the exports are currently headed, and what the prospects are in those countries. It is very important to take note of the fact that Germany's strong export performance has been to countries like the UK, and Spain, who may now struggle in the wake of the sub-prime crisis, and to large chunks of Eastern Europe, where some key economies may now be on the point of undergoing a major correction. The fact of the matter is that German exports to the Czech Republic were roughly equal in value last year to German exports to China (and both of them were less than, say, German exports to Poland). That is a good measure of the importance of the Czech Republic for the German economy, but it is also a measure of just how poorly positioned Germany actually is in China, and generally throughout emerging Asia as we move forward. At the end of the day exchange rates do matter, and perhaps the recent visit of EU dignitaries to China (and what they have realised during their visist) has as much to do with Mr Steinbrueck's change of heart as anything.

Postcript: the astute reader will note that out of the eurozone big four - Germany, Italy, Spain and France - there is no real mention of the Frech economy in this post. This is largely becuase, important as it is to the eurozone, Claus and I by and large take the view that the French economy is "Monsieur Average" in eurozone terms. By this we mean that the French economy - despite an ever present need for adaptation and reform - is very far from being the European sick-man some ideologues would make it out to be, just as the US economy - and see this excellent piece from MacroMan - is far from being the global economy sick man another group of ideologues would have us believe (isn't it curious how most of the ideologues like to line themselves up around an axis which goes from France to the United States?). So growth in France will be what? Well guess - average, neither powering the euro economy forward, like Spain has done in the strongest moments of its housing boom, nor acting as a sheet-anchor drag like Italy tends to do in the worst of her downswings. Indeed, given this Monsieur Average quality a good argument could be made that France is the one eurozone economy that has been exposed to more or less appropriate monetary policy and interest rates since the inauguration of the euro. And guess what, interest rates, just like exchange rates, do matter.