Thursday, July 24, 2008

The Eurozone - That Sinking Feeling?

By Claus Vistesen Copenhagen

One need not be well versed in the art of reading entrails or posses any other kind of unworldly powers to see that the Eurozone economy may be about to head off over the cliff. Now, just as the Q1 GDP figure was something of a technical glitch due to the forward pushing of investment which made Germany ride an impressive 1.5% reading q-o-q, so is the corresponding Q2 figure likely to be a similar (negative) glitch. The only important question is the extent of the slowdown since without that, we really cannot build any sound forecasts for an annual growth rate of the Eurozone, not to speak of Germany itself.

Yet, if we move beyond the immediate excitement of the upcoming GDP release and the extent to which it will have vultures gathering over an increasingly weak economy, the forward looking indicators also turned an abysmal showing. Consider then the following: In Italy, business confidence slumped to the lowest level in seven years; in France, it clocked in at the lowest since 2005 and in Germany the ever so important (for ECB policy that is) IFO survey declined to a three year low.

But the show does not, by any means of the phrase, stop here. Adding to the gloom we also got the PMI release showing its lowest reading since 2001.

Furthermore, in Spain where it isn't the proverbial Rome but moreso Madrid (or perhaps the Cedulas?) that are burning, an already groggy economy got some additional blows in the kidneys (see also below) as we learned how secondary inflation rose to an all time highs at one and the same time as the economy shed jobs in Q2 to move into double digit territory with respect to the unemployment rate. As for real economic data, consumer spending in France added a near final nail to the coffin by dropping 0.4%. Furthermore, data released on French builders also confirmed that slowdown as the index slid two points. Builders noted in particular how order books were judged to be less vibrant than normal as well as they see a slowdown in activity for the next three months.

There can be little doubt that the data releases above are suggestive of the fact that the Eurozone may well be heading for a full blown recession in Q2 and Q3. In that light, Trichet also moved in lately, and with good reason, to reassure us that while the next two quarters would see a "trough" in economic growth we would revert to normal services from Q4 and onwards.

Two important questions arise then.

First of all we have the obvious question of just how far the this slowdown will drag on and as a derivative what kind of trend will we revert to? As I have stated above it is really difficult to say anything remotely sane about GDP outlook until we get Q2 numbers (currently the Eurozone is standing at a 2.8% annualised q-o-q with Germany at 6% annualised q-o-q (!), and I am sure not even the greatest optimist would venture such a call). However, for me the question about the "trend" or "normal" pace of growth is much more interesting since my feeling is that the underlying momentum of a post recession Eurozone will surprise on the negative side. As such, it is not about the potential recession itself since these things come and go (although with a bit too high frequency in some countries it seems), but much more so it is a question about the Eurozone which emerges and what we can reasonably expect in terms of overall gusto.

A Step too Far?

Amidst all this doom and gloom and recession sabre rattling some would perhaps feel inclined to point out that the ECB seems to be getting just what it ordered with its recent 0.25% rate increase as oil prices have dropped smartly in the past weeks. I can see this point, if anyone should feel like making it, but I am also sure that we can all agree that oil prices these days are moved by more than the ECB. In fact, a raising ECB in so far as it would pummel the USD should not make oil go anywhere but up.

Meanwhile, the governing council at the ECB must obviously be watching the incoming barrage of poor data with more than a faint eye since it comes just weeks after rates were increased. Now, I should make it clear that this was the ECB's intention all along. Ever since the crisis began it was obvious for everybody that it would push the business cycle into reverse but the ECB always opted for inflation over growth; or at least it did not succumb to the temptation to lower rates. Now the butcher is coming to collect his bill and it could seem as if the ECB's credit card is in for a nasty overdraft. Actually, this may turn out to be a quite literal conceptualization if the Spanish mortgage market is about to turn into a pile of smoldering bricks.

To sum up, Q2 GDP will be interesting to watch since it will give us a sense of overall direction. Other than that I am watching Germany very closely and most specifically the export link with Eastern Europe. Basically, Germany have been living on exports not only to its main trading partners in the Eurozone (who are all now slowing considerabl) but also on the margin to the CEE economies. Especially this last link is about to break now and the repercussions will be swift and severe in terms of economic momentum lost. Finally, one cannot help but feel that Spain may be in for the worst of all (perhaps even worse than Italy). The link between builders and their banks seems a crucial issue to watch going forward.

Want More?

Below you will find a list of statistical reports used in this piece as well as other reports. This is for the analysts and investors who want the gory details.

France Business Survev (INSEE) - Enquête mensuelle de conjoncture dans l’industrie – Juillet 2008

France Business Survev (INSEE) - Enquête mensuelle de conjoncture dans le commerce de détail et le commerce
et la réparation automobile – Juillet 2008

France Consumer Spending (INSEE) - Dépenses de consommation des ménages en produits manufacturés - Juin 2008

France Building Activity Survey (INSEE) - Enquête mensuelle de conjoncture dans le bâtiment - Juillet 2008

Germany - IFO Survey, July 2008

Spain (INE) - Industry New Orders Received Indices and Industry Turnover Indices, May 2008

Spain (INE) - Industrial Price Indices, June 2008

Spain (INE) - Services Sector Activity Indicators, May 2008

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