Tuesday, 18 June 2013

Europe: Converging, if not quite surging…

Today’s ZEW surveys were consistent with our theme of a convergence between the economic performances of Germany and the broader eurozone.  The eurozone-wide economic sentiment index recovered somewhat after a fall in May and remains consistent with a general improvement in industrial production. 
Source: Eurostat, ZEW
The German Economic Situation index was weaker than expected but remains at a healthy level, while forward-looking German economic sentiment continues to improve.  

The euro has been recovering in recent weeks on the back of this kind of improvement in data. This morning it was already performing well following a speech from ECB President Mario Draghi in which the case for further easing remained muted. The equity market, however, particularly welcomed these results.  Thursday will see the temperature taken for this recent improvement in eurozone data, however, when the purchasing managers indices are published.  We think these will show further improvement.

In order to recreate the eurozone in its own image, Germany has required the periphery to undertake an incredibly painful internal rebalancing - that means suffering wage declines that historically would have been masked by higher inflation and a weaker currency.  The evidence of success is limited. Whilst Spanish labour competitiveness seems to have improved, the reality is that official statistics fail to capture former employees who have moved into the black economy (on the same basis however unemployment is overstated).  

Such informal labour markets were already well-established in France and Italy and continue unabated.  Bringing participants back within the taxable labour force is a necessary step on the path to competitive tax rates but, at the same time, is politically challenging and will weigh on consumption.  Tough times therefore remain ahead before the eurozone's current cyclical upturn can be considered safe and sustainable growth.

Guy Foster
Head of Portfolio Strategy

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