The pace of capital goods orders in Germany in March suggests a further slowdown in investment in OECD countries over the coming months. Orders are down 5.9% year-on-year and this indicator is closely correlated with the investment profile of OECD countries.
This slowdown in orders is global. The rebound in the Euro zone is limited since over a year the decline in orders is still -6.5%. The rest of the world does not look encouraging either.
This is why I have doubts on the investment profile published by INSEE yesterday for the manufacturing sector for France. A 11% growth is expected for 2019 after 0% in 2018. This seems excessive since the survey shows a rapid slowdown in the second half. This means that the first semester has to be very strong. This is not necessarily consistent with what we see in the pace of investment of non-financial companies in the first quarter. The survey is probably a bit too optimistic. Capital goods orders continue to contract in April 2019. I do not imagine strong investments in France while the rest of the world is rather in an investment slowdown.
Growth resumes in the Eurozone. For the EA, it is 0.4% and for Spain 0.7%. Even Italy is recovering and returning to positive territory. France disappoints. Despite strong measures taken on purchasing power, political uncertainty penalizes activity. It could last
INSEE, the French statistical institute published its new forecasts for the first half of this year. (Its forecasts are just for a semester to avoid being in conflict with the government expectations). Activity would increase by 0.4% in the first and second quarters (non annualized rate). INSEE slightly revised up its second-quarter figure. The carryover growth for 2019 would thus be 1.1% at the end of the first half. To reach the new government forecast at 1.4% (indicated by Bruno Le Maire while the budget for 2019 had a forecast at 1.7%), quarterly growth has to be at 0.4% for each quarter. The current trend for the first semester would therefore be extended to the whole year. This figure, 1.4%, is also the one recently published by the Banque de France.
The articulation of the INSEE forecast is based on two elements.
The first is the rebound in domestic demand in the first months of 2019. On this point, all experts agree. The measures that have been taken on purchasing power should be support for household consumption. The pace of growth of this one would thus pass from an average figure per quarter of 0.125% in 2018 to 0.5% in the first quarter and 0.4% in the second. (Measures to boost the purchasing power have been taken after yellow vests’ protests. The amount of these measure is around Eur 11bn)
The second element of the framework drawn by INSEE is the momentum associated with the international environment. The Institute considers that the slowdown seen at the end of 2018 is just temporary and that the situation will rapidly improve to regain a more robust outlook. The demand’s profile to France from the rest of the world is unchanged from the INSEE’s December economic outlook. And this is a fairly solid figure, rising 0.7% in the first quarter and 0.9% in the second, while the average figure for 2018 was 0.5% per quarter.
If the strong slowdown of the last quarter, which conditioned the strong downward revision of the OECD forecasts (from 1.8% to 1% for the Euro zone) and the ECB (from 1.7% to 1%), is reversed then the outlook may be robust in coming months. Such a conjecture implies a rather robust pace for exports as world trade regains a stronger track. It also implies a rebound in business investment, as expected demand would recover. In that case, a strong recovery can be expected as companies’ financial situation will improve dramatically in 2019 (Lower taxes which was a policy proposed by Hollande in 2013 will be replace in the future by lower charges on wages. But in 2019 both measures are available as the new measure will be put in place and the former has a one year lag. This is a opportunity for firms. They will take advantage of that if expected demand improves dramatically).
If the global shock is persistent then the pace of exports will be less sustained and the investment will be gloomier. The improvement of financial conditions are only permissive conditions but not decisive when the expected demand is mediocre. The pace of employment will also be conditioned by the persistence or not of the shock.
If one assumes a more persistent shock from the rest of the world then the figures are less robust beyond the jump of the first quarter and without being catastrophic growth would tend to 1.1- 1.2% on average for 2019. And this does not suggest necessarily a re-acceleration of growth in 2020 as suggested by the Banque de France.
The key element will therefore be the overall momentum beyond the short-term effects of government measures. The Fed, the OECD and the ECB are wondering about the pace that this global dynamic can have. The Fed no longer wants to make commitments (on the pace of interest rates and on the reduction of its balance sheet) in order to be able to respond to a possible global shock without having hands tied. But France resists this mood.
In the first months of 2019, the economic situation will largely depend on domestic demand and therefore the measures taken by the government on purchasing power. An immediate consequence is that the government will not be able to engage in a policy of reducing public spending which is a precondition for a credible reduction in taxation. An expenditure reduction policy would annihilate support measures. The public deficit will therefore remain high, probably at best around 3.5% in 2019.
The French GDP growth was 1.1% (at annual rate) during the fourth quarter of last year. The same number than during the third quarter. Social unrest has had no impact on the headline figure. Nevertheless, details show that the private sector domestic demand stalled (0.2%) during the last quarter after a strong 2.4% growth in the third quarter. Households’ consumption was 0 and investment contribution was at 0.2% versus 0.9% in Q3. On companies’ side, investment contribution decreased on the same scale (0.2% after 0.9%). Residential investment was down with a negative contribution (-0.1%). The good surprise was on exports’ side with a strong increase at 9.8% vs 0.7% in the third quarter. Therefore and despite a rapid imports’growth, the external demand contribution was positive at 0.9% after 1.1% in Q3. Inventories have had a marginal negative contribution.
For 2018, the average growth was at 1.5% after 2.3% in 2017 but the end of 2017 was the peak of the cycle and the economy is now converging to its potential. In 2019, with 1.2% per quarter which is close to the 2018 average, growth will be at 1.1%. We have a forecast at this level. It way below the government forecast at 1.7%. We can’t expect a strong reversal in the GDP momentum that could justify such a forecast. In 2019 consumption will be pushed up by all the measures on purchasing power that has been announced by the President Macron in December. But as long as social unrest remains companies will not boost their investment. The improvement seen on exports will not last. World trade is slowing down rapidly and France will follow this trend. In other words, the French economy has a limited growth momentum (just 0.9% from Q4 2017 to Q4 2018). With social unrest and uncertainty on external trade, the French economy will continue this trend close to 1% in 2019.
Careful observation of the French economy provides some insight into the swift escalation in social unrest since November. The initial question of purchasing power sparked off the movement in November. At the start of the financial crisis, purchasing power was not too severely hit initially due to the hefty impact of automatic stabilizers, i.e. economic mechanisms that help even out the effects of shocks over time via redistribution. This system had worked fairly well in the past, keeping GDP fluctuations down during economic downturns. This is one of the key aspects of the French redistributive model. With a continued weaker macroeconomic situation than in the past, the economy adapted. Three major changes can help shed some light on the social strife that has been dragging down the French economy.
The first problem is that French economic trend growth is now more sluggish than before the 2008/2009 crisis, and this has an impact on purchasing power trends. We can analyze this situation using the chart below, providing an overview of purchasing power trends on the one hand (demand) and productivity data on the other (supply). The purple line shows the trend in purchasing power per consumption unit and the blue line plots productivity (GDP per hour worked). We can see that these two indicators ran parallel before the 2007 crisis, then diverged until 2012/2013 before converging again, although with weaker trend growth than before the crisis. Under normal circumstances, these two indicators should move at a similar pace, and a long-lasting divergence is not feasible i.e. wages cannot be disconnected from income creation via the production process
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.
For French households, the future has darkened during the last two months. The household confidence index plummeted in December and households’ perception of their own situation or that of all French people is at a very low level, not necessarily very different from that observed during the post-Lehman shock period. 2008/2009. This is a measure of the feeling of what is happening in France today. The difference is that in 2008/2009 the shock was external and in a way it was enough to wait for the effects to fade. Today the shock is endogenous, it has its source in the very dynamics of French society. When we look at the year-on-year change in the household confidence index, we can see that the shock is stronger than in the winter of 1995 when the French economy froze. The consequence is that households can no longer project themselves into the future. The perception of their own situation is very degraded leading to a more wait-and-see attitude, leading to a deterioration of the economic situation, feeding a vicious circle. To get out of it, the government must propose measures in rupture that could change very quickly everyone’s perspective to avoid dramatic political excesses. It is he who has the responsibility and it is certainly not by accentuating the tax burden that the solution will be found.