Global Daily – Can eurozone domestic demand survive the global slowdown?

by: Aline Schuiling , Bill Diviney

Euro Macro: Gap between manufacturing and services activity widens – The final estimates of the eurozone PMIs showed that the gap between activity in manufacturing and services widened further in March. Indeed, the difference between the eurozone manufacturing PMI (down from 49.3 in February to 47.5 in March) and services sector PMI (up from 52.8 to 53.3) widened to -5.8, up from -3.5 in February. At its current level, the gap between manufacturing and services is the widest since early 2009, when world trade collapsed during the global financial crisis. We think the current widening of the gap again reflects a sharp deterioration in global trade. Indeed, within the group of the largest eurozone countries, the manufacturing PMIs of Germany, the Netherlands and Austria have dropped the most since the middle of 2018. These countries all have a high share of goods exports in GDP (Germany and Austria around 40% and the Netherlands around 65%). Belgium also has a high share of goods exports in GDP (85%), but does not publish PMI reports. Germany is the only one of the four ‘open’ countries that publishes a manufacturing as well as a services PMI, and the gap between the two widened to more than -11 in March. On the other side of the spectrum are France, Spain and Greece, which have a relatively small share of goods exports in GDP (France and Spain around 20% and Greece around 10%) and also saw a relatively modest decline in their manufacturing PMIs.

Looking ahead, we expect global trade to improve modestly in the second half of this year, which should result in a pick-up in manufacturing output in the eurozone. This would be largely due to the dovish policy shift that has been made by the world’s main central banks, which has resulted in some easing of global financial conditions. On top of that we expect the uncertainties surrounding Brexit and the global trade conflict to ease in the course of this year (also see our publication Trade Wars – is the EU next in line?). In our base case scenario, the damage to eurozone domestic demand should remain contained to investment in machinery and equipment, which tends to move in sync with exports and has also weakened since the middle of last year. In contrast, private consumption, government consumption and residential investment should remain resilient and prevent GDP growth from moving into negative territory. Indeed, we expect GDP growth to be around 0.1-0.2% qoq in 2019H1 and to rise to close to the trend (0.3-0.4% qoq) in 2019H2. This view was supported by a separate report published today, which showed that eurozone retail sales increased by 0.4% mom in February, following a 0.9% rise in January. Combined with a recovery in car registrations, this should result in private consumption growth strengthening somewhat in 2019Q1 after it expanded by 0.2% qoq in 2018Q4. That being said, we think that the risks to our scenario for the eurozone economy are tilted to the downside. In particular, if the global slowdown were to last longer than we think, domestic demand will eventually be pulled down. (Aline Schuiling)

UK Macro: Weak services PMI points to economic stagnation – The services PMI took another leg lower in March, falling into contractionary territory at 48.9 (Feb: 51.3), suggesting Brexit uncertainty is exerting a bigger drag on economic growth in the UK. This followed an upside surprise to the manufacturing PMI on Monday, although much of that surprise was driven by inventory building (Brexit-related stockpiling) that is likely to unwind over the coming months. Indeed, the stocks of both finished goods and purchases indices in the manufacturing PMI rose to record levels of 55.9 and 66.2 respectively in March. Given the services sector is by far the bigger driver of growth in the UK, the composite PMI fell to 50.0 from 51.5 in February. Our base case continues to be that a long delay to Brexit will happen before there is any resolution to the uncertainty, although the pathway to that could be bumpy given the level of cabinet opposition to such a delay. As such, we expect uncertainty to continue to weigh on economic activity over the coming months, and have subsequently downgraded our growth forecast for 2019. We now expect growth of just 0.8% in 2019, down 0.3pp from 1.1% previously, and well below consensus (1.3%) and Bank of England (1.2%) forecasts. We maintain our 2020 growth forecast at 1.7%, on the expectation of an investment rebound once there is more clarity on the pathway forward. In any case, given the weak nearterm growth outlook, we do not expect the Bank of England to tighten further this year. (Bill Diviney)