Euroland Industrial Production Sank 2.5% saar Last Quarter

August 13, 2008

Forecasts centered on a 0.8% decline of Euroland GDP at an annualized rate might be too conservative.  June industrial production released today revealed a 2.5% drop last quarter and put the level of production at the end of the quarter already down 0.6% (not annualized) from the 2Q mean.  For June alone, industrial output was unchanged m/m and off 0.5% y/y.  Production of capital goods, consumer durables, and intermediate products each fell between May and June, and only a 1.0% increase in energy, which will not be sustained, kept the overall figure from dropping.  Large June 2008-over-June 2007 production decreases were reported for France (2.5), Portugal (4.2%), Finland (3.3%), Spain (9.0%) and Italy (1.8%).  Production for the whole euro area fell 0.5% in the year to June, a 4.5 percentage point adverse swing from a rise of 4.0% in the year to April.

There was other bad news from the common currency bloc lately.  The PMI readings for July were at 47.4 for manufacturing and 48.3 for services, each below the 50 line of demarcation between expansion and contraction and each with forward-looking new orders scores (respectively at 43.8 and 47.7) that were lower than the overall scores.  Germany had been counted on to blunt Euroland weakness but saw its volume of retail sales including the automotive sector collapse at a 9.1% annualized rate in the quarter.  In Germany, too, factory sales fell each month from February through June, and real export growth was negative in 2Q08.  In 2Q, factory output and construction slid by 6.2% saar and 28.8%.  Industrial orders slumped 15.4% saar last quarter, including a 10.8% drop in domestic demand for capital goods, which foreshadows an adverse trend in business investment in 2H08.  If Euroland doesn’t have its German cylinder firing, what source of internal or external support can it count on?  Not much, and that is why the third quarter also is shaping up as a negative one for GDP growth and why ECB officials are backing off their previous forecast for a revival of activity commencing as early as 4Q08.  Like Japan, Euroland has limited scope for a policy rescue.  High actual inflation poses further risk of a rise in core inflation, which accelerated to 2.5% in June from 1.9% a year earlier, so ECB officials are reluctant to cut interest rates until they see total inflation crest.  A lack of fiscal consolidation when Euroland was enjoying above-trend growth leaves governments with scant leeway now to introduce significant fiscal support.  The euro still has a higher Deutschemark translation value than that currency’s all-time peak of 1.345 per dollar hit in March 1995.  My point there is that despite backing away from $1.6038 in mid-July, the euro remains uncompetitive especially at a time when key export markets like Britain and the U.S. are hurting, too.

How ironic it is that U.S. growth remains positive when so much red ink is being spilled in Europe and Japan.  That surprising development is the cyclical basis for the dollar’s better tone this month and for lower oil prices.  The lesson is that the U.S. business cycle still exerts powerful influence over the rest of the world economy.  But what comes around goes around. The fact that Europe, Japan, and many emerging markets are developing along weaker growth trends than assumed 2-3 months ago probably spells trouble for the United States, too.  On domestic criteria, many analysts have reversed their original U.S. macroeconomic thinking of a recession in 1H08 followed by recovery in 2H08 and are flagging the possibility of a recession in 2H08 spilling over into 2009.  The intensifying weakness of global demand makes that possibility all the more likely, and if that happens, the cyclical basis for a rising dollar will get muddied.

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