Recent data on the German industrial production show a rapid drop in the economic activity. The quarterly change was already at -5.5% in the third quarter (annual rate). At the end of November, the carryover for the last quarter of 2018 is at -7.8%. There is a strong consistency between the quarterly change in the industrial production index and the GDP as it is shown on the graph. During the third quarter of 2018 the GDP was down -0.8% and related to the strong decrease in the German production this winter, the GDP may again shift downward in the last quarter. Germany would then be in recession. The impact could be strong on the Euro Area’s momentum and leading to a downward revision of the EA growth forecast (the starting point for 2019 would be lower). The convergence to potential growth (1.6%) would then be quicker than expected. The ECB will not change its monetary policy before long.
What were last week’s major changes? The main change was in Italy with a strong and rapid drop in the interest spread with Germany.
Why ? Since the new coalition government came to office, fears have emerged on exactly how the campaign-trail program would translate into the forthcoming budget – an answer to this question is expected on September 27.
The government’s stance so far has been to be fairly relaxed, especially on the 3% threshold (of budget deficit as % of GDP), which explains why the yield spread with Germany widened considerably over recent weeks.
This was a source of concern as the Italian economy would soon have run up against financing difficulties due to the reluctance of non-resident investors – who hold around 35% of the country’s debt – to revisit the Italian market after withdrawing their investment in the country all summer. Italians cannot and do not want to leave the euro area, so additional pressure on liquidity and interest rates could have hampered funding for Europe as a whole.
However, the economic situation is swiftly changing in Italy, as economic activity slowed sharply over the summer months, Continue reading →
Mario Draghi’s stance is guarded. His latest press conference gave no indication of the change in communication tone that we are set to see from the European Central Bank in January.
The ECB is finally taking on board the strength of the economic cycle and so its communication stance must adapt to this shift. This is rather good news, as the central bank constantly appeared to be acting in reaction to an environment that could swiftly deteriorate, and this shift can bolster our confidence in the strength and length of the economic cycle. The other point noted by the ECB is the move away from an exclusively inflation-based focus and towards a more broad-based communication tone. This implicitly means that the ECB is extending its reach, but really when it comes down to it, this was already the case: the ECB’s intervention has hinged on the economic cycle rather than inflation since the euro was adopted in 1999. The chart below shows the Markit composite index and the difference in the ECB main refinancing rate over 5 months, and reveals that changes in the second indicator are clearly dictated by changes in the economic cycle, rather than in inflation.
After the failure to form a coalition the first thing to notice is that Merkel is no longer at the center of the game. She has been replaced by the German president, Frank-Walter Steinmeier, who will decide what will be the next steps.
These steps can be threefold
1 – A coalition between the CDU-CSU and the social democrats of the SPD but the SPD is reluctant to participate.
2 – A minority government but with the risk of doing nothing while important issues have to be managed (the current negotiation failed on the refugees’ question, on carbon emissions, on taxes and on education) These are important issues that cannot be postponed.
3 – New elections at the beginning of next year
I favor the third possibility but my guess is that in this type of situation domestic questions are at the center of the discussion or of the campaign.
European questions were not at the center in recents days but with Merkel’s recent point of view was a kind of guarantee that Europe would not be forgotten.
It could be the case in a foreseeable future if Merkel is no longer the leader. Europe could then be erased from discussions
The recent improvement in the perception of Europe is twofold.
1- GDP growth is stronger and employment is improving rapidly
2- The commitment between Merkel and Macron to improve the way institutions are working at the European level
If Merkel is weaker and focused on internal issues then European reforms will no longer be on the agenda
This would create an uncertainty that could reduce the economic horizon then limiting investment and the possibility to improve the potential growth. Therefore it can have a negative impact on growth and could be damaging.
Another point on reforms is that with stronger growth it limits the risk of populism. If, because Merkel is no longer at the center of the picture, reforms are not done then we will see the convergence to a lower growth trend rate and more that the come back of populism with the risk of weaker institutions. Some nationalists want to exit from the EU.
The political process in Germany is at risk not only for the Germans but also for Europeans as the current momentum would become more fragile opening the door to populism
The impact on Brexit negotiators will depend on the result of the current political process. A bias positive to populism would a piece of cake for the UK government as populists do not like Europe. It would be the worst situation for a European citizen.
The GDP growth was 1.7% (at annual rate) during the fourth quarter of 2016.It was a mere 0.4% in the third quarter. For 2016 GDP was up 1.8% after 1.5% in 2015.
The carry over growth for 2017 at the end of 2016 is 0.5%. It was the same number at the end of 2015 for 2016.
Domestic demand is currently the main support for growth with a high contribution from government expenditures. Since the first quarter of 2015, GDP growth is +1.5% on average and the government expenditures’ contribution is +0.7%; Almost half of it, that’s a large number (data until Q3 2016, the detail for Q4 is not available yet).
Construction is also an important contributor.
Government expenditures and construction are the German response to the refugees’ crisis, leading to a more autonomous .growth. Net exports have a negative contribution (imports were up due to a robust domestic demand).
Growth in Germany follows now a more autonomous and centered growth framework. It has a positive and persistent impact of the Euro Area growth.
The first graph shows the stability of the German business cycle. There is no break in the crisis contrary to what was seen in every other developed country. This reflects the absence of rupture in the private domestic demand. (The break in 2008 is mainly associated with external trade in Germany)
The second graph shows the cumulated contributions of different sources of demand to GDP growth. On the right part of the graph we see that the main sources of growth are the private demand and government expenditures. Since 2013, the net exports contribution is almost neutral (no upward trend).
This support from domestic demand is a source of improvement for the Eurozone
The third graph is the government expenditures’ quarterly contribution to GDP growth since 2015. On average GDP growth was 1.5% and the contribution was 0.7%.
According to companies’ survey in Germany and in France the economic activity was marginally down in August. German’s companies were a little more pessimistic for the 6 month period to come.
Even if levels are different we perceive in the following graph that there is a kind of stability in economic activity during the last twelve months. This synchronization of the business cycle suggest that France and Germany cannot really expect a stronger growth momentum in the short run. In other words, it seems that German and French economic activity are not able to accelerate from their current level. It’s not worrisome for Germany as its unemployment rate is low but it is problematic for France as its unemployment rate is just below 10%. As there is no impulse from outside as world trade trend is flat, it means that the impulse must come from inside. The ECB has done the job so we must expect a more proactive fiscal policy in order to jump on a higher trajectory. Continue reading →
GDP growth for the Euro Area was confirmed at 0.3% (flat) for the second quarter of this year (2.2% at annual rate).
The table below shows growth figures for different countries of the Euro Area.
In the largest Eurozone countries there is a slowdown during the second quarter. This is the case for Germany (from 2.9% to 1.7%), for France (+2.7% to -0.2%) for Spain (from 3.1% to 2.8%) and for Italy (from 1.1% to 0%) Growth is stronger in other countries.
Carry over for 2016 at the end of the second quarter is 1.3% for the Euro Area but 1.5% for Germany and 2.6% for Spain; but just 1.1% for France and 0.6%% in Italy. For other countries it is circa 1% except for Greece where it is still negative. Continue reading →