IN-DEPTH: A reality check for the euro area

The problems facing the Eurozone economy are neatly illustrated by fresh German data showing soft exports and contracting factory orders. While Chinese fiscal stimulus should help get Europe’s biggest economy back on track, expansionary fiscal policy across the bloc, as well as interest rate normalisation, are also necessary to ameliorate the ills of the euro area as a whole.

The euro area faces two main issues: low credit impulse and the Chinese slowdown and “Discussions among ECB watchers are notably evolving around the idea of pushing the repo rate back to zero” Europe needs some fiscal stimulus There is no such thing as global decoupling. Unsurprisingly, headwinds from China’s slowdown are starting to hit Europe and the US. The Organisation for Economic Co-operation and Development’s euro area leading indicator, which is widely used by asset allocators globally, has fallen sharply over the past few months. The year-on-year rate stands at its lowest level since the end of 2012.

At the same time, large declines in core European industrial production data can be observed, especially in Germany, which accounts for one-third of European industrial activity. This slowdown came as a shock for many policymakers, but we feel that it was predictable. Over recent quarters, our leading indicators (notably credit impulse) led us to warn clients and investors against the risk of lower growth in Europe.

Low credit impulse and China The euro area faces two main issues: low credit impulse and the Chinese slowdown. The euro area credit impulse, a key driver of economic activity, is running at 0.4 percent of GDP, which is rather low compared with its four-year average of 0.8 percent. A country-by-country analysis shows that the risk of growth decoupling between core countries and the periphery of the euro area is emerging again. In France and Germany, credit impulse is positive, at 1.7 percent and 0.6 percent of GDP respectively. By contrast, the credit impulse is sharply decelerating in the periphery; it was close to zero in Q4‘18 in Italy and sits at -2.1 percent of GDP in Spain, a level not seen since the end of 2013. This tends to indicate that a more restrictive credit cycle, especially in the periphery, has started. This will have a negative impact on domestic demand as it is highly correlated to the flow of new credit in the economy, and ultimately on growth as well.

On the top of that, the euro area, which has been more and more reliant on Asian growth since the financial crisis, is hit hard by low economic activity in China.

Germany’s factory orders, at constant prices, are in contraction and close to their 2012 nadir. In other words, we are looking at a decline in the manufacturing sector months ahead as well as weak sentiment in the automotive industry.

Digging further into the data, the most striking chart is German export growth to China, which has fallen sharply since the beginning of 2018 and is now in contraction as well.

The bright side is that China has opened the credit tap again, starting in the spring of 2018. We expect Chinese economic stabilisation by Q3 and a positive impact to Europe by Q4’19-Q1’20. Meanwhile, domestic measures to stimulate the economy need to be taken at the European level. Our main macro takeaways for Q2’19 – The euro area is reacting late to cyclical downturns in the domestic credit market and in trade developments.

– We see growing risks to growth in the periphery of the euro area and we expect that Germany will experience disappointing growth this year.

– The outcome is likely to be more fiscal expansion after the EU parliamentary elections and further monetary stimulus in a tricky period for the ECB as it will be looking for its next president.


Source from: The Peninsula