Tuesday, January 08, 2008

EU Commission Eurozone Economic Sentiment Index December 2007

Evidence of a 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 as measured by the PMI also fell across the entire 13 nations euro bloc in December, with sales falling in France for a third consecutive month (the December index came in at 49.1), while a Italian sales dropped to 44.7 from 45.3.

This general impression is confirmed by the latest release today from Eurostat, which shows European retail sales fell the most in at least 10 years in November (the latest month for which they have released data) as rising food and energy continue to hit the consumer's wallet. Retail sales declined 1.4 percent from a year earlier, and this is the biggest drop since at least 1997. Sales also fell 0.5 percent from November, which was the third decline in four months.

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

EU Commission Confidence Index Down All Round.

The general picture of an economic slowdown in the eurozone is once more highlighted by yesterday's realease of the December data for the EU Commission Eurozone Economic Sentiment Index.

The Commission’s economic sentiment indicator is on a clear downward path. At 104.7 in December, down from 104.8 in November, the index was at its lowest since March 2006.

But perhaps more important than the steady downward drift in the general indicator are the individual country differences.

As can be seen, the all important German economy is slowing steadily, although not as fast as some. Part of the reason for this may be the unusual performance of the German labour market. This is a pretty complex matter, and I feel that simplistic interpretations may be sending some analysts straight up the garden path here. I have a long (beware, I mean very long) post studying this problem here, and I will publish some summary results on this blog in due course.

Italy, as I have outlined in greater depth here, has been steadily drifting off towards its next recession since the middle of 2007, but the big news of the moment is what is happening in Spain and Ireland, since as is well known they were the two countries in the eurozone to be most affected by the "housing fever" boom, and if you look at the chart above the correction in these countries since September is striking in its velocity. As the FT comments:

Spain is demonstrating that prospects could vary significantly across the eurozone. Since September, confidence in the Spanish construction sector has tumbled, and the Commission’s survey results showed sentiment deteriorated in December in Spanish industry, retailing and among consumers as well.

I have two very extensive posts on the Spanish situation on my Spain blog (here and here) and I will post a summary here in due course.

But not everything in the Eurozone is bad news at the moment. Take France, for example.

And Yet France Resists!

As the above chart illustrates, France is slowing, but it is not slowing as fast as the rest of the group, and so we may hope that it is the French economy which can do some of the heavy lifting to sustain the eurozone economies in future quarters, since this downturn is going to be an especially difficult one given that the normally boyant Spanish economy will be in the sick ward along with the customary Italian and German patients. This view may surprise some readers, since it is not normal to speak postively about France at the same time as mentioning Germany as a downside element, but then facts are facts and not mere opinion, and this is a moment when all the narratives about how things actually work are going to be well and truly tested, and I fear that "goldilocks" opinions like those currently being advanced by Morgan Stanley's Elga Bartsch are going to be found severely wanting (especially her German powerhouse argument, presented in her xmas "Pulling a Slow Train" post which you can find here. In that post she actually says - and I quote directly - "Germany could well be on the way to becoming the new growth locomotive in Europe. The phase of underperformance in terms of GDP growth, which has plagued Europe’s largest economy for years, is clearly over." As I say, I think this is to misunderstand what ha sbeen happening in Germany, and what the macro issues which present themselves there really are, but in any event we are all going to get to see soon enough).

Basically there are strong demographic grounds for imagining that France (just like the United States) is not in as bad a shape economically as some imagine (as Claus spelt out in this post back in early 2007, where he explains why France is not, in economic terms, "the sick man of Europe") despite having severe institutional deficiencies and a very poorly functioning labour market. Some call all of this an example of my demographic "tunnel vision", but the nice thing about economics is that theories are testable - if you accept the judgement of the data - so I would simply ask the skeptics to bear the argument in mind and follow the data as we move forward.

In fact French Gross Domestic Product grew by 0.8% , in the third quarter of 2007according to revised estimates from the French statistics office Insee published last week. One of points which stood out in this data was the strong performance of domestic consumption -a d here France differs considerably from both Germany and Italy - with household expenditure rising by 0.8% ( following 0.6% growth in the second quarter of 2007). This surge in domestic consumption contributed 0.4 percentage points to quarterly GDP growth. General government expenditure slowed from a 0.5% y-o-y rate in Q2 to 0.4% and thus only contributed 0.1 percentage point to Q3 GDP growth.

Total Gross Fixed Capital Formation (GFCF) grew at an annual 0.6% rate (0.4% in the previous quarter). The GFCF of households grew by 0.6%. In total GFCF contributed 0.2percentage points to GDP growth. Exports growth also increased (1.5% following 0.7% in the previous quarter), while imports grew more slowly, by 1.0% (after 1.8% growth in Q2), so that changes in 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).

A glance at the long term annual growth chart for the French economy gives some indication of why I am so confident that France will weather the storm better.

Despite the fact that France - just like everyone else - gets recessions, there is much more soliditity and regularity in the growth, and the trend is much higher than that to be seen in Italy, for example.

And when we come to Germany, even though the line is not as negative as it is in Italy, a clear downward movement in trend growth can be observed. But please observe the bounce-back after 2002, and especially the sharp upspike after the begining of 2006. That is what all the debate is about. Is this trend sustainable? Demographics says it isn't. Conventional analysts like Elga Bartsch say it is. Now we are going to see who is right, and hopefully modify and calibrate our models accordingly.

Strong Points and Weak Points in France Looking Forward

Euro zone purchasing managers surveys for the manufacturing sector also tend to confirm the idea that the economy of most eurozone member states has been slowing 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 coming in at 49.1,

However French consumer confidence in unexpectedly dropped to a 19-month low in December. 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.

So nothing is perfect. France will note the slowdown. My argument is simply that it will note it much less than some of the others. As far as I acn see at present, Spain and Ireland may well be the first ones formally into recession, closely followed by Italy, with Germany holding out just a little bit longer, and only really dropping in the wake of events in Eastern Europe, on which her exports are heavily dependent. Basically, to orient yourself here, it is important to understand that the eurozone countries are enetering the present recession with all the key policy indicators acting as headwinds (the precise opposite of the situation in the US. The ECB are stubbornly sticking to "inflation vigilance" (while the Fed is giving greater emphasis to providing a platform under the economy and easing), inflation is biting into consumer purchasing power (ditto the US in this case), the euro is at very high levels which presents problems for exports and sucks in imports (both of which are negative for GDP, and the US dollar is of course falling, making exports more competitive and acting as a brake on imports), and at the same time the 3 month euro libor, despite some recent reduction, remains stubbornly high, making it more difficult for banks to sustain liquidity and hence more reluctant to lend (again, the Fed has been somewhat more successful in easing 3 month interbank rates. So there it is I'm afraid, downwards we go with a big push from the available policy instruments.

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