Macro Weekly – European outlook still challenged, but no change in view

by: Han de Jong

  • European drop in business confidence moderates, except in Germany
  • We still think the softness is temporary
  •  And we stick to our base scenario of sustained above-trend eurozone growth this year

Due to a bank holiday in Holland last week and travel later this week, this weekly comment is coming out today. Next week’s weekly will also appear on Wednesday

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My colleagues and I have written about softness of the eurozone economy before. The softness is most visible in the drop of business confidence, though it was also confirmed by the Q1 GDP numbers. The drop in business confidence has been more pronounced than we were expecting and the question it raises is whether we must lower our growth forecast for the year as a whole. And if so, by how much. The short answer is that we think the softness is temporary and we are not changing our above-trend growth forecast for the eurozone economy for this year at this point in time.

What the heck…?

When, as an economic forecaster, you are confronted with data that is not consistent with your view, this poses and interesting challenge. What the heck is happening? The eurozone manufacturing PMI peaked in December and has fallen in April to the lowest level since March 2017. The ‘expectations component’ of the authoritative German Ifo index has fallen even more sharply. It peaked in November last year and in April reached its lowest level since April 2016. Meanwhile, the confidence indices in the US have done better, so you cannot say that it is simply a global pattern.

This isn’t perhaps as bad as it sounds. These and other confidence measures were at multi-year or even multi-decade highs and some drop was inevitable. In addition, they were higher than the harder data could justify. So to some extent, we may be witnessing a process of normalisation. However, the hard data has also shown some weakness, albeit much less so than the confidence gauges.

I have in the past discussed some temporary factors that may have played a role. Bouts of adverse weather in Q1, strikes and even the flu epidemic could be the culprits. The appreciation of the euro over the last 15 months may also play a role. Then there are two more possible candidates: the threatening, US initiated trade war and slowing world trade growth, driven by China.

Germany hit harder

What may point to the importance of the trade-war skirmishes is the fact that Germany seems to be harder hit by the weakness in business confidence than most other eurozone economy. Germany is running a large bilateral trade surplus with the US (and a large overall surplus on the current account of the balance of payments, for that matter) which has attracted the wrath of US president Donald Trump. Although it is not likely that the US would impose trade restrictions on Germany without imposing them on other EU countries, German businesses may simply be more aware of the issues. Anecdotal evidence suggests that the trade disputes appear more prominently in the German media than in the media in most other EU countries.

The other possible candidate to explain eurozone weakness is slowing world trade growth, most likely led by China. The economy of the eurozone is more open than the US economy and also has a larger exposure to the Chinese market, which may explain the fact that the eurozone economy is affected more that the US’s.

Chinese data distorted, but seems all right

The problem with this line of thinking is how to back it up by data. Normally, one would simply look at the trade flows. Unfortunately, China’s trade flows are heavily affected by Chinese New Year, making year-on-year comparisons very difficult. The yoy numbers for January (strong) and February (weak) were clearly distorted, but it is impossible to estimate by how much. So we must look at subsequent numbers. Chinese yoy import growth bounced back handsomely in March, including imports from Germany. Other economic variables in Asia have been mixed recently. The April PMIs in China were a touch better than expected and certainly did not indicate serious weakness. PMIs in South Korea and Taiwan, and also Malaysia were softer, but PMIs were stronger in India, Indonesia and Thailand. While all this evidence is inconclusive, it does not suggest that there is a sustained, material slowing of global world trade growth.

Eurozone corporate capex appears to be very strong

Other developments in the eurozone continue to suggest that the eurozone economy will be OK. Stronger growth of corporate investment is one of our themes for 2018. That still seems likely. While growth of business investment was not weak in 2017, we expect it to be stronger this year. Capital goods orders from other eurozone countries placed with German manufacturers grew 7.1% yoy last year, but the growth rate over the last three months up to February has risen to 14.7%. In addition, bank lending to non-financial corporates continues to accelerate.

On balance:

While our above-trend growth forecast for the eurozone economy this year has recently been challenged by published survey results and hard data, continued solid growth is still more likely than not.