Global Daily: Eurozone economy flat

by: Aline Schuiling , Bill Diviney

Euro Macro: Eurozone economy close to stagnation in Q2 – The first estimate of eurozone Q2 GDP growth will be published on Wednesday. We expect growth to have been close to zero, which is below the consensus forecast of 0.2% qoq, and a significant slowdown from the 0.4% qoq that was recorded in Q1. One reason for the slowdown in growth is that there will be payback for a number of one-off factors that lifted growth in Q1. To begin with, new car registrations bounced back in Q1 after they were depressed in 2018H2 due to the introduction of new emission standards. On top of that, construction activity was lifted by mild winter weather. The two combined had an upward impact on GDP growth of around 0.3pp, implying that underlying growth was very modest in the first three months of the year. Since then, monthly activity data have not shown improvement while various sentiment indicators (PMIs, consumer and business confidence, economic sentiment, etc.) have declined. Indeed, the weakness in global manufacturing that started in the course of 2018 has continued in 2019H1 and will probably also persist during the rest of the year. This will continue to weigh on eurozone exports and industrial activity and will also increasingly leave its mark on the services sector and domestic demand. As a result, we expect the economy to remain close to stagnation in 2019H2. Combined with weak inflationary pressures (see below) this strengthens the case for a new package of stimulus measures by the ECB (see here).

France published its Q2 growth data already today. It showed that growth declined from 0.3% qoq in Q1 to 0.2% in Q2, which was in line with our below-consensus forecast. The details of the GDP report reveal that the slowdown was concentrated in manufacturing (according to the written press report largely due to disruptions in energy production due to maintenance) and construction. On the expenditure side of the economy, growth in private consumption slowed down in Q2, with car registrations particularly weak, but consumption of services grew more moderately as well. In contrast, fixed investment growth strengthened (to 0.9% qoq in Q2, up from 0.5% in Q1). Looking forward, we expect the French economy to continue to outperform the eurozone total somewhat. This is largely thanks to the fact that France is less dependent on exports and/or industry than for instance Germany, the Netherlands, Belgium and Italy and, therefore, not hurt as much by the decline in global trade and the uncertainties related to the global trade conflict. On top of that, economic reforms and the stance of fiscal policy are supporting domestic demand.

Euro Macro: Core inflation to fall back – Germany, Spain and Belgium published July inflation numbers today. In the largest country Germany, HICP inflation declined to 1.1%, down from 1.5% in June. Detailed regional data suggest that the decline was concentrated in core inflation, particularly services price inflation. Food and energy price inflation was roughly unchanged in total in most regions. In Spain, HICP inflation increased slightly, to 0.7% in July, up from 0.6% in June. The written press statement mentions that food and drinks were the main reason for the rise, implying that core inflation was roughly stable. Finally, in Belgium only national CPI inflation was published. This fell to 1.4% in July, down from 1.7% in June, with the decline spread amongst core inflation and food and energy price inflation. Eurostat will publish the eurozone aggregate inflation data on Wednesday. We expect core inflation to decline from 1.1% to 0.9% and headline inflation from 1.3% to 1.0%. (Aline Schuiling)

BoE Preview: MPC likely to keep its powder dry for now – While the Fed’s expected rate cut on Wednesday is the main focus for markets this week, the Bank of England’s policy decision on Thursday is also drawing attention given the increased fears in markets of a no-deal Brexit, and following some dovish remarks by typically hawkish MPC members last week. For instance, prominent hawk Michael Saunders said last Tuesday ‘the economy right now is clearly not overheating — the underlying pace of growth … is weak and below trend’. We and the consensus look for policy to remain on hold at this Thursday’s meeting, but looking further ahead the risk is undoubtedly tilted towards an easing of policy given the weakening in growth momentum and the significant risks to the outlook.

With that said, the case for an easing of policy is not quite as clear cut as it is in the US. First, inflation is currently at the Bank of England’s target of 2.0%, wage growth recently accelerated to a 11 year high of 3.6% yoy, and inflation expectations are elevated. Second, while the BoE has hiked rates twice by 25bp, the current Bank Rate of 0.75% remains firmly in accommodative territory – well below the estimated neutral interest rate (c.3.4%, according to the latest Holston, Laubach & Williams estimate). This is in contrast to the US, where the starting point for the effective fed funds rate is at neutral (2.40%). Finally, the recent c.7% depreciation of sterling will already provide stimulus to the economy, as well as add to inflationary pressure. As such, while an easing of policy is likely in the event of a no-deal Brexit – and the economic downturn that it would likely result in – we expect the MPC to remain in ‘wait and see’ mode for the time being. (Bill Diviney)