Macro Weekly – Eurozone resilient, UK recession

by: Nick Kounis

  • Early post-Brexit PMI survey indicators suggest the eurozone economy is resilient up until now…
  • …though there was a hit to confidence raising risk of weakness ahead
  • Meanwhile, the UK looks to be heading for recession, with the PMI contracting at the sharpest pace since the global financial crisis
  • The ECB is in wait-and-see mode but will probably ease further in September, while we think the BoE will announce a bazooka in August
Macro-Weekly-22-July-2016-1.pdf (80 KB)

Eurozone so far resilient to Brexit…

Early data suggest that the eurozone economy is coping well in the aftermath of the UK’s vote to leave the EU. However, there were signs that confidence has been hurt, and this may be a future headwind to activity. The eurozone composite (or whole-economy) output index dipped only slightly in July (to 52.9 from 53.1 in June). Though it did represent an 18-month low, it is not far from the levels seen for most of this year, with the index being trending around the 53 level. This is consistent with GDP growth of around 0.3% qoq. The indexes reporting on trends in output, orders and jobs remained resilient.

…but signs of hit to confidence

On the other hand, business optimism in the services sector deteriorated significantly. That index fell to 59.9 in July from 62.6 in June, taking it to the lowest since December 2014. Weaker business confidence, if sustained, could negatively impact decisions on output, orders and hiring in the coming time. So it is far too early to signal the all clear, especially since Brexit is actually seen having an adverse impact via an ‘uncertainty shock’.

Only modest growth in prospect

Our sense is that the PMI and GDP growth will soften and we expect the economy to grow only modestly in coming quarters. This should leave underlying inflationary pressures extremely subdued opening the door for further monetary easing in coming quarters (see below).

Periphery relatively weak

Looking at the country breakdown, both the German (55.3 from 54.4) and French (50 from 49.6) composite indexes rose in July. The fall in the overall index for the eurozone therefore suggests that the peripheral economies were hit more significantly, though the breakdown of the other economies will only be released later.

UK economy looks set for recession

The comparable survey for the UK economy made for depressing reading. The composite output index collapsed in July. It fell to 47.7 from 52.4 in June, taking it to the lowest level since April 2009. The index is pointing to a fall in GDP of around 0.5% qoq. One of the most dramatic indicators in the survey was seen in service sector business expectations. This index fell by more than 10-points taking it to the lowest level since January 2009. This emphasises that the uncertainty shock is taking hold and is already having a major impact on business activity.

The PMI has been one of the more reliable indicators of the UK economy and is consistent with our base case that a recession is on the cards. It also supports the view that the BoE will ease policy aggressively in August and that sterling has further to fall. We expect a 25bp rate cut, an expansion of QE (of GBP 150bn) and an easing of BoE lending conditions for banks.

ECB in wait-and-see mode

The ECB kept its policy rates and target for asset purchases on hold as expected yesterday. In the press conference following the decision, ECB President Mario Draghi stressed that there was a lot of uncertainty about the outlook, but that the central bank was ready to act if needed once a clearer picture emerged. This would possibly be in September in the light of the central bank’s new forecasts. During the Q&A Mr Draghi went out of his way to stress the ECB’s ‘readiness, willingness and ability to act’ if needed.

We expect the ECB to step up its QE programme in September (with monthly asset purchases rising to EUR 100bn from EUR 80bn). In addition, it is likely to extend the programme to the end of next year, compared to the soft deadline of March 2017 currently. The ECB will need to also announce measures to expand the eligible universe of public sector bonds in order to meet these targets (see our note here for more).