Wednesday, 15 May 2013

Even the hardcore rocks…

Today saw a number of eurozone Gross Domestic Product (GDP) reports.  The headline was of continued eurozone recession (-0.2%) but there was a lot of information to be gleaned from the individual country performances.
Schadenfreude? The German economic miracle is tarnished (Source: ZEW/German Federal Statistics)
All eyes were on Germany which is the ‘hard’ core of the eurozone.  Recent evidence has shown the economy begin tipping into the mire with other parts of the union.  Yesterday the ZEW survey revealed a very bleak assessment of the current German economic situation from businesses.  We also saw weak wholesale prices following on from a sharp decline in consumer price inflation last month.

German GDP was expected to rebound 0.3% from a weak fourth quarter of 2012. In fact it was just 0.1% up, and that was based on a revised-down fourth quarter – dare we say it? Within a whisker of a double-dip recession (which may yet be confirmed by revisions).

…the rest of the core is soft too

If Germany is the hard core then France is the ‘soft’ core and the news there was disappointing too.

France had been expected to recover from a -0.3% decline in Q4 2012 to a -0.1% decline at the start of 2013, but fell -0.2% instead.
Oo la la! Consumer prices and growth weakening in France (Source: Eurostat)

France also reported weaker consumer prices both in absolute terms and relative to expectations (year-on-year French prices rose just 0.7% versus expectations of 0.9%).  These numbers chime with the trend of weaker CPI prints from the rest of the eurozone and, more broadly, the world.

The rest of the core was pretty pedestrian too. The Netherlands remained in recession reporting -0.1% shrinkage – in line with expectations.  Meanwhile, Finland provided some indication that its weakness is moderating, although the country is already in recession and retail sales dipped.  Austria posted unchanged GDP growth which, again, was roughly to be expected.
Finnished? Not quite but retail sales and growth remain weak (Source: Finnish Statistics Office)
A perfect storm?
The story here is one of economic convergence in the eurozone.  Why is it happening? For a number of reasons.

Germany’s great strength has been its export sector, not just in terms of the mix of goods, but also in terms of the mix of destinations – China being the jewel in the German export portfolio crown.  With Chinese data continuing to suggest more subdued growth, German businesses are likely to feel that weakness.

Just as demand is weakening, so supply may be starting to become more competitive.  Germany, as an export-orientated economy, competes with Japan in a number of automotive, electronic and industrial sectors.  That means the dramatic increase in currency competitiveness which Japan is achieving through the devaluation of the yen risks creating a perfect storm for Germany.
The euro is weaker and equities fell after the GDP results were published, but hopes of further policy stimulus seem to have maintained the ‘bad-news-is-good-news’ mantra.  Overall, markets see these numbers, coupled with weaker inflation figures, as offering the perfect excuse for the European Central Bank (ECB) to ease monetary policy.  The question is whether the current discussion of negative interest rates turns out to be a genuine policy option, or an example of slight of hand by ECB President Draghi.  With the suggestion having also been mentioned by the Bank of Italy governor, Ignazio Visco, the proposal is looking increasingly serious.

In the periphery conditions remain weak but the pace of decline is slowing, fitting with the theme of economic convergence.  Italian GDP, having slowed -0.9% in the final quarter of last year, lost a further -0.5% this year – cold comfort indeed. The Portuguese and Greek economies all saw sharp rebounds in their growth – from -1.8% to -0.3% in Portugal and -2.8 to 0.2% (positive) in Greece. 
Soft core...growth rates converge in the eurozone (Source: Eurostat)
The ECB will need to start easing soon and that is going to mean a very strong monetary environment.  If no further stimulus is forthcoming then markets will be disappointed.  On the other hand, provided the ECB meet expectations, what will be the new investment mantra?

“Don’t fight the Fed, or the Bank of Japan, or the ECB…”

Guy Foster
Head of Portfolio Strategy

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