The publication March’s Markit indices confirms the downward pressure on activity in the manufacturing sector. The leading indices published for the Euro zone, Germany and France, on March 22, have been revised downward. This is never a very good signal as to the strength of the activity. This revision was marginal in the Euro zone (from 47.6 to 47.5) and in France (49.8 to 49.7) but more marked in Germany from 44.7 to 44.1. This latter has not been so low since July 2012. For the Euro zone, the index has not been as low since June 2013 but at the time the movement was bullish while here it reflects a deterioration of the activity. For the other two major countries, Spain and Italy, there is a slight rebound in Spain from 49.9 in February to 50.9 in March, but the Italian situation continues to deteriorate, from 47.7 to 47.4.
A good explanation is the pace of international trade. Germany is frankly penalized by the contraction of trade due to an openness rate higher than 44% of GDP. Any shock on world trade has an immediate impact on it. More generally, because of the intensive trade between countries of the zone, any external shock is amplified by a contagion effect and penalizes the activity of all. This had been a very positive uptrend in 2017 but is declining today. Germany saw its export orders revised downwards compared to the March estimate (38.9 vs. 39.5 initially). For France, the figure is unchanged.
The proactive economic policy of the Eurozone can only be seen on monetary side with a very accommodative policy but it cannot go further in that direction to limit the impact and the spillover effect of the shock. Except for a sudden and unexpected reversal of world trade, the trend in the Euro zone is here to stay. It should be possible to support domestic demand for this through budgetary means. This is not the current mood at the European level even if France plays constrained by the social unrest
The modest rebound in the IFO index in March is sometimes interpreted as the counterpoint to the drop of the Markit index released last Friday. There is indeed an opposition in March between the pace of the two indicators. One goes up again while the other is down.
However, what shocked in the Markit survey is the sharp downturn in the manufacturing sector, while the services sector was doing quite well. The manufacturing index was 44.7 against 47.6 in February. It contracts for the third month in a row. In contrast, the composite services indicator (calculated as the non-manufacturing ISM) is stable in March at 53.7 as in February. The culprit is the manufacturing index. Yet when comparing the manufacturing index of Markit and that of the IFO we have exactly the same profile.
The peak of the two indices is almost the same and the break observed since the beginning of 2018 is similar. The shock on the German economy reflects the rapid slowdown in the world trade momentum. The impact on the German economy is through the manufacturing sector whether measured by IFO or Markit. The pace of service between the two measures is not the same and this is what differentiates synthetic indicators from the two surveys. But services are more reflective of the domestic market than the sensitivity of the German economy to world trade via the manufacturing sector. The external shock is strong and brutal in Germany and it has first to be stabilized before the beginning of a recovery. It will take time and this justifies the pessimistic forecasts for Germany.
With the decline of -0.9% in December, the industrial production of the Euro zone fell by -5.3% over the last quarter (annualized rate). and -2.1% over one year. The slowdown in world trade is an explanation that the European slowdown has itself accentuated.
There is now a more complete picture of industrial activity in 2018. The US is doing well, Japan is still very volatile but Europe is falling back quickly, lacking an internal dynamic capable of offsetting external shocks. We always fall back on this eternal question of coordinated dynamics to get better. Dependence on impulses from the rest of the world is now too important and this is very worrying
The inflation for the Euro Area was at 1.4% in January after 1.6% in December. The main reason for this drop is the negative impact of the oil price. The energy contribution to the inflation rate was 1% in October and just 0.25% in January. This will continue and the contribution will become negative during the first quarter of this year. This reflects that the oil price is currently lower than in 2018 and this will continue allover the year. As the core inflation rate is circa 1%, the headline inflation rate will close but below 1% in 2019.
Except in the US, the mood perceived through all the Markit surveys is negative. In the Euro Area the index is just above 50 at 50.5 but the German index, its main engine, is now in the contracting zone. Japan is converging rapidly to 50. This US will not have the possibility to pull up the global activity. Its momentum is not strong enough. Moreover, this US index has also to be interpreted with the Fed new monetary policy framework. The US central bank has stopped its monetary policy normalization at its January meeting and I can’t imagine that it’s mainly linked with external downgrades. It would be the first time ever that the Fed makes a change in its monetary policy orientation on external elements. I can’t believe that the Fed change is not dependent mainly on the US outlook.
The French economy remains under pressure at the beginning of 2019. Business leaders do not want to commit to the long term because of the uncertainty that hangs over the immediate situation. Since November, there has been a clear drop in orders for capital goods. It may imply a sharp slowdown or even a decline in productive investment around the turn of the year.leading to a low trajectory. The protracted social unrest is beginning to weigh on employment, as shown by the rapid slowdown in hirings as measured by the French Social Security for the fourth quarter of 2018. We can not spontaneously wait for relay from the European countries. The composite indicator calculated by Markit for the Euro zone is at its lowest since July 2013. The impetus will not come from there. The difficulties of reducing social uncertainty will weigh on the profile of 2019 growth, which will probably have to be revised downwards. We must now think about a growth rate of around 1% for the whole year. The “Grand Débat” launched by the French President Emmanuel Macron to reduce the current social unrest and the preparation of the European elections next May, where new lists (yellow vests) appear, will maintain this deleterious climate. This will not help either employment or purchasing power. France goes around in circles.
The euro area economy is slowing and could even see a contraction around the end of 2018 due to recessions in Germany and Italy, along with very weak momentum in France. The trend has changed at a faster pace than had been expected at the start of 2018, when the consensus was for similar trends to the very robust growth in 2017 i.e. no acceleration but continued swift economic growth. This pointed to expectations of more self-sustaining growth via jobs, income and investment, thereby driving a more independent trend that could safeguard some of the euro area’s economy against potential external shocks. This quickening decline is worrying as the situation in a number of countries has gone from solid to shaky, for example Germany, where external trade is now hampering growth, along with Italy and France where domestic demand is no longer on the desired trend. This quickening decline is worrying as the situation in a number of countries has gone from solid to shaky, for example Germany, where external trade is now hampering growth, along with Italy and France where domestic demand is no longer on the desired trend.
Why this perception of a swift deterioration in the euro area economy? The first harbinger that all economic observers picked up on is the very swift deterioration in economic indices as measured by business leaders surveys. From a peak in the last quarter of 2017, the composite index slid swiftly and steadily right throughout 2018, failing to display a recovery. This trend is revealed in the euro area Markit manufacturing sector index, which slowed severely and sustainably in sync with world trade, with an accompanying drop in domestic and external orders.
The horizon darkens faster than expected in the Euro zone. The German figures published this morning (January 8) suggest that the economy is heading towards recession (its GDP had already fallen in Q3). Italy, also with declining GDP in Q3, has negative signals via business surveys. It is also probably in a recession. The French economy lacks vigor, social unrest weighs heavily on the macro dynamics.
In other words, 65% of the Euro zone is probably in decline in the last quarter of 2018 (German and Italian declines do not make up for France’s slight rise). This creates a mediocre momentum and a real concern for the pace of growth of the area for the coming months. In a context where inflation will be reduced, this will result in poor nominal growth that will not have the ability to create and distribute income. Better coordination of economic policy is a necessary condition (but probably not sufficient) to find a satisfactory trajectory. Alas, we do not take that path. The two Italian deputy prime ministers blow on the French embers and do not encourage to imagine a serene future.