Slight drop GDP in Q2 2012 hides large country differentials
Sentiment again gloomier
Markets waiting for game changer
Industry fairly stable, for now
Domestic demand weakest link, but exports looking fragile as well
Uncertainty grips EU as risks mount and action is delayed
In the 2nd quarter of 2012, GDP fell 0.1% QoQ in the EU27 and by 0.2% in the Eurozone. However, this relatively mild contraction of EU economic activity hides largely diverging trends at the country level.
Particularly in Germany, economic growth was sustained at a reasonable pace despite strengthening headwinds at home and abroad. Most neighboring countries in Northern Europe managed to avoid a decline and saw economic activity growing at a tepid pace.
Meanwhile, economic strains in Southern Europe intensified over the 2nd quarter, with most countries sinking deeper into recession. Also the UK remained in recession.
The key drag on economic growth comes from the weakness in domestic demand. Government and household consumption expenditure and private sector investment remained under severe pressure.
The Eurozone debt crisis is taking its toll on domestic demand in the EU through the adverse interaction between growth stifling austerity measures, inadequate European policy responses, financial market stress, risk aversion and weak market sentiment.
However, negative effects of the Eurozone debt crisis are not restricted to the Eurozone countries. Elsewhere, confidence is also negatively affected and lower demand from Europe is having implications on economic growth for the US and particularly the export driven economies in Asia. Due to slowing growth momentum in world trade, support from exports to EU economic activity in the 2nd quarter weakened. Indicators head further south Economic indicators deteriorated further in recent months and signal that a short term improvement in economic fundamentals is not to be expected.
The EU economic sentiment indicator fell in September to the lowest level in three years’ time on a further sharp drop in consumer, services’ and retail trade confidence. Sentiment in the construction sector improved slightly while remaining at a very depressed level, whereas industrial confidence moved sideways. In October, economic sentiment stabilized in the EU, but declined further in the Eurozone.
The Eurozone Manufacturing PMI averaged only 45.1 in the 3rd quarter of 2012, the weakest reading since mid 2009. There was a slight improvement in October, but it is definitely too early to see whether this could be the start of a stabilization or even improvement in sentiment in the months ahead.
The current low levels of confidence reflect that uncertainty has taken hold across all sectors of the economy, from the financial sector to services, industry, construction and consumers, fuelling risk aversion and stifling growth.
The key question is what could change economic sentiment to the extent that risk aversion will start to fade and investment and private consumption will strengthen again. Recent action undertaken by the ECB contributed positively in at least temporary reducing worries about a disintegration of the Eurozone.
The announcement of the Outright Monetary Transactions program which allows for unlimited purchases of government bonds has already had a positive effect on bond yields in Spain and Italy.
The European Stability Mechanism getting the green light from Germany’s Federal Constitutional Court was another important step in strengthening the backbone of an EU monetary union.
It is now up to the national governments to make a decisive turn in fighting the crisis. The ECB will only come into action if a country applies for aid from the EU and the IMF. However, any ECB intervention will come with strict conditions and controls which are still unknown and will have to be respected by the applicant country.
Other action by EU policymakers is required on the actual implementation of the agreed plans for an EU fiscal union, the recapitalization of the EU banking sector and flanking support programs to offset harsh austerity measures in order to stimulate growth and job creation and improve competitiveness in the peripheral Eurozone countries affected most by the debt crisis.
Details on how to make real progress on these important issues are still lacking. Until real progress has been made on these issues, uncertainty will continue to be fed by concerns about the viability of the Eurozone and whether policymakers will deliver on promises made earlier. Industrial activity fairly stable, for now despite weaker confidence in the industrial sector, total output remained fairly stable so far this year. However, closer examination of the underlying country data reveals that this is basically thanks to still robust activity levels in Germany and its neighboring countries in Northern Europe.
The situation is much worse in the south of Europe and the UK; in Spain industrial activity is now below the trough reached in the crisis year 2009. Another concern is that industrial activity has been primarily supported by existing order backlogs built up in 2011, whereas the intake of new order has been disappointing. Particularly new bookings for investment and intermediate goods for the internal market have been on a weakening trend since mid 2011.
The steady erosion of order books is confirmed by the marked deterioration in the assessment of order book levels since the start of this year. The manufacturing sector will remain vulnerable as long as fears for a more pronounced global slowdown and difficult private sector funding conditions continue to weigh down on the general business climate and particularly on market wide risk appetite.
As a consequence, EUROFER’s forecast for investment growth has been adjusted downwards to a drop of almost 3% in 2012 and zero growth in 2013. Although some improvement in international trade is penciled in for 2013, on the assumption that several emerging countries will take measures designed to strengthen their domestic economies, the positive contribution from export demand on industrial production growth will be only moderate.
As a result, also the outlook for industrial production growth has become more bearish: output is expected to decrease by 2 to 2.5% this year, followed by only minor growth in 2013.
As mentioned before, it is particularly domestic consumption in the EU which is affected by the adverse interaction between austerity, risk aversion and weak market sentiment.
Several countries, such as France and Spain, have taken steps toward even more severe austerity programs which will impact the budget for 2013 and reduce government consumption expenditure. Current forecasts from EUROFER’s Economic Committee show government consumption falling by 0.5% next year.
Consumer confidence deteriorated quite sharply in recent months; in September 2012 the lowest level since May 2009 was reached followed by a low level stabilization in October 2012.
At the consumer level, the general feeling of economic uncertainty is compounded by negative news coming from the labor market and weak or even negative disposable income growth perspectives due to direct and indirect tax increases and still relatively high inflation which is not compensated through a rise in gross incomes this year or next.
The Eurozone unemployment rate increased to 11.6% in September 2012, 1.1% percentage point up on September 2011. A similar trend can be identified for the EU27 with unemployment rising to 10.6% in September 2012.
At the current and expected GDP growth rate for 2013, the outlook for the labor market remains depressed; unemployment will most likely increase further during 2013 due to weak private sector hiring and governments shedding public sector jobs. This implies that consumer retrenchment will continue to dampen private consumption growth, which is currently forecast to stagnate in 2013.
In combination with sluggish investment growth, the outlook for domestic consumption in 2013 is weak. Nevertheless, the base case scenario is still for a minor relative improvement in domestic demand to take place during 2013 owing to a moderation in the pace of fiscal consolidation across the EU. Assuming that sufficient progress will be made on providing stimulus measures to the ailing Eurozone economies and on improving the health of the EU banking system, confidence should improve from current low levels. In the financial sector, this should also translate in a gradual easing of current restrictions on access to finance for enterprises and private households.
The ECB kept its promise to do whatever it could to save the euro and responded adequately to the deteriorating economic outlook for the Eurozone and rising financial market stress on concerns about the speed of necessary reforms in the peripheral Eurozone and EU policymakers' willingness to undertake coordinated action in case of a further significant deterioration of the Eurozone debt crisis.
The OMT program is aimed at combating sovereign bond market distortions, which will make speculation on national defaults or countries having to leave the Eurozone less attractive.
The positive reaction of the financial markets on the announcement of ECB's bond buying program and the German ratification of the ESM and inflation remaining above the 2% target rate enabled the ECB also to keep interest rates unchanged at the historic low of 0.75%.
Eurozone inflation amounted to 2.6% in September 2012, up on the average rate in the preceding months due to a rise in the cost of energy and services.
According to the ECB, priority is now on fixing the region's banking system so that the funds injected by the central bank funnel broadly and equally through its economies. However, the ECB does not rule out additional rate cuts. Euro to remain relatively weak having fallen below USD 1.20 in July 2012, the Euro strengthened again on ECB's actions in support of the single currency to slightly above USD 1.30 by mid September 2012 and managed to hold up rather close to that level until now.
However, pressure on the Euro could return and lead to an increase in volatility. This could be triggered by disappointing economic data and indicators signaling that EU recession could last longer than anticipated which would most likely result in another ECB interest rate cut.
Also Spain or Italy formally asking for ECB intervention could raise financial stress again due to the unavoidable delays between the moment of applying for support and the actual intervention caused by the necessary steps of negotiating the support program's conditions and checks and controls.
The current period of economic slump in the EU is characterized by low levels of confidence across all sectors of the economy which, together with financing restrictions, fuel risk aversion and paralyze domestic demand.
At the same time, sluggish growth in other advanced economies and a moderation in economic momentum in the emerging world curbs export demand from abroad. In the absence of clear indications on how policymakers in the EU will solve the crisis and against the background of economic momentum in the emerging countries losing steam, the economic outlook for the EU is surrounded by even higher risks and uncertainties than anticipated before.
This is reflected in the latest forecasts from EUROFER’s Economic Committee. GDP in 2012 is now forecast to fall by 0.4%, in 2013 followed by a marginal rise of 0.4%.
The key assumption for this base case scenario is no further major escalation of the Eurozone sovereign debt crisis. Adequate policy action should result in a hesitant return of confidence to the markets while gradually improving financial conditions.
Another assumption is that the global economy will overcome current headwinds. Supported by a more supportive fiscal stance in the emerging countries and US avoiding the so-called fiscal cliff, global economic growth should see some recovery in 2013.
Undoubtedly, the key risk for the EU as well as the global economy is EU policymakers failing to deliver on promises made earlier and to implement the support and reform programs agreed during several summits. This implementation risk could result in a longer and possibly deeper recession in the EU than currently anticipated in the forecasts and with strongly negative effects on global economic sentiment and growth.
Eurozone disintegration fears will fuel financial instability in the region. Rising risk aversion will speed up the process of bank deleveraging which will backfire on credit availability and growth prospects.
The threat of a Greek exit is still alive. Greece has been negotiating with the European Union, International Monetary Fund and the ECB to unlock a 31.5 billion euro tranche of the rescue package. Should parliament fail to approve a new round of austerity measures needed for a lifeline from creditors, the country could be forced out of the euro. This would further undermine confidence and spark off speculation about contagion to other debt-ridden Eurozone countries.
Another risk is rising uncertainty in the United States surrounding the year end fiscal cliff; if Congress fails to decide on renewal of existing measures, tax increases and spending reductions coming into force in early 2013 could tip the US economy back into recession back into recession.
The macro economic risks surrounding the EU and US creates also significant uncertainties for the export driven emerging economies in Asia, in particular for China.
Meanwhile, the Chinese exports and investment driven growth model appears to be nearing its limits. The government is trying to reduce China's reliance on external dynamics by strengthening domestic demand; this process will take years rather than months. In the meantime, slowing export demand from the advanced economies will exacerbate the slowing trend in the Chinese economy and dampen overall economic momentum in Asia. This risk is however somewhat mitigated by the resources available to the Chinese policymakers to support the economy in case of a more protracted slowdown.
A risk of a different category is mounting geopolitical tension in the North Africa and the Middle East. Interstate conflicts in the region are not to be excluded. This would have the usual repercussions on oil and gas supply from the region and send prices higher. This would have a negative impact on economic sentiment in the advanced economies.
EUROFER forecast for October 2012 EU
|||2010||2011||2012 (f)||2013 (f)|
|Investment in mach. equip.||4.5||3.3||-3.1||-0.1|
|Investment in construction||-3.5||-0.5||-3.2||-1|
Source - EUROFER