Euroland: The Feel of a Recession
September 9, 2008
Second-quarter growth was negative 0.8% at a seasonally adjusted annual rate with drops of 4.6% saar in business investment, 1.5% in exports, and 0.6% in personal consumption mitigated by a rise of 2.2% in public expenditures. I think third-quarter growth is going to be negative as well, and the fourth quarter will be at best scantly positive. To be fair, real GDP had advanced 2.7% saar in 1Q08 and by a brisk 2.5% per annum between 1Q05 and 1Q08. A slowdown was needed anyway to contain the buildup of inflationary pressures. ECB officials still think the worst of this lull will fall into 2Q and 3Q. If correct, the cycle will soon stabilize and then start to improve. However, forward-looking indications of sentiment were still deteriorating in August. Overall economic sentiment that month in the Bloc fell to 88.8 from 89.5 in July and quarterly averages of 96.5 in 2Q08 and 100.5 in 1Q08. Euroland’s PMI trends have been much weaker than their U.S. counterparts.
| U.S. | Ezone | U.S. | Ezone | Sum of | |||
| Services | Services | Spread | Mf’g | Mf’g | Spread | Spreads | |
| January | 44.6 | 50.6 | -6.0 | 50.7 | 52.8 | -2.1 | -8.1 |
| February | 49.3 | 52.3 | -3.0 | 48.3 | 52.3 | -4.0 | -7.0 |
| March | 49.6 | 51.6 | -2.0 | 48.6 | 52.0 | -3.4 | -5.4 |
| April | 52.0 | 52.0 | 0.0 | 48.6 | 50.7 | -2.1 | -2.1 |
| May | 51.7 | 50.6 | +1.1 | 49.6 | 50.6 | -1.0 | +0.1 |
| June | 48.2 | 49.1 | -0.9 | 50.2 | 49.2 | +1.0 | +0.1 |
| July | 49.5 | 48.3 | +1.2 | 50.0 | 47.4 | +2.6 | +3.8 |
| August | 50.6 | 48.5 | +2.1 | 49.9 | 47.6 | +2.3 | +4.4 |
Germany, followed by France, Italy and Spain in that order, are the Euro-zone’s largest economies. The top three posted negative growth in 2Q, while Spain eked out a marginal uptick of 0.4% saar. Dutch growth was -0.2%, while GDP increased in Greece, Finland, Belgium and Portugal. If Germany does well, so does Euroland usually, but the converse is equally true. And Germany is not displaying the kind of resilience that had been hoped. Industrial orders in the region’s biggest economy have not recorded an increase since November and were 3.8% lower in July than their 2Q mean, with drops of 6.6% in domestic orders for capital goods — a portent of a continuing contraction of business spending — and 2.7% in export orders. Industrial production was 2.4% lower in July than its 2Q average level. The volume of retail sales on a similar comparative basis was down about 3.0%. Between January and July, exports slipped 0.9%, whereas imports rose by 5.1%. Germany had been hitting on all but one cylinder, the exception being private consumption. Now, consumption remains in the doldrums, and exports and business investment have joined it. The German trade surplus in July of EUR 11.8 billion was substantially below June’s EUR 18.9 billion and the EUR 16.9 billion per month pace from last October through June 2008. In Euroland as a whole, real retail sales fell 3.5% in 2Q and were 0.8% lower in July than the 2Q level.
The ECB raised its key rate in July by 25 basis points to 4.25%, and the anti-inflation tone of last week’s press conference suggests that this move will not be reversed until 2009 and probably not at the start of next year, either. Producer prices in the Bloc rose 11.2% saar in 2Q08 and by 9.0% in the year to July. Officials maintain that the risks surrounding an above-target forecast of CPI inflation next year of 2.3 – 2.9% still lie to the upside despite a few hopeful signs. Moreover, more restrictive requirements for collateral covering the ECB’s special liquidity infections are likely to augment the tightness of credit market conditions when they take effect in February. A very important export market, Britain, has darker clouds over its economy than even the ones surrounding the euro area. The United States economy did better than feared in 1H08, but prospects still look ominous in light of falling employment and a 1.1 percentage point jump in the jobless rate between April and August.
Not all the news is adverse. World oil prices have tumbled about 30% since mid-July. The euro is around 12% below its dollar peak. Inflation has probably crested and will be subsiding, paving the way for the ECB to cut rates next year. Much is riding on the continuing resilience of demand from emerging markets. Maybe too much. Most private analysts, myself included, suspect that growth at least over the the coming three quarters to mid-2009 will be weaker than the ECB assumes. Some expect the malaise to persist through all of next year. When it’s all over, a recession lasting more than two quarters will have played out, and market participants will be left to wonder yet again if Euroland will ever manage to decouple itself from a U.S. economic downturn.
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