Signs of stabilisation
10 July 2018
The latest ‘hard’ data for the Eurozone as a whole have continued to deteriorate, with industrial production declining by 0.9% in April, and retail sales falling 0.1% in April before flatlining in May. The trade balance narrowed further in April, which is a drag on overall growth, although car registrations and construction output are both a little better so far in Q2. Taken together, the overall message has generally been downbeat. But the more leading (in theory, at least) ‘soft’ surveys paint a brighter picture. Admittedly, the ZEW, Sentix and EC confidence surveys were all weaker in June, but they remain at elevated levels by historical standards. And the Eurozone composite PMI survey rose to 54.9 in June, driven by a rebound in the services sector and new orders – the latter boding well for future growth. It is also notable that the composite PMIs in Germany, France and Italy, the Eurozone’s three largest economies, all rose in June. Finally, there have been tentative signs of a bounce in some of the other incoming data of certain member states, mostly obviously German industrial production, factory orders, and exports for May. Bringing all of this together, our Nowcast is pointing to 0.4-0.5% quarter-on-quarter growth in Q2 and Q3 (see Chart 6), broadly in line with our subjective forecasts and consistent with the worst of the Eurozone slowdown now being in the past.
Of course, the single currency area still faces a number of headwinds to growth that weren’t present even six months ago, which means that the risks to our growth forecasts are probably tilted to the downside. Trade tensions are clearly hitting sentiment, and an escalation, especially if it included tariffs on European car exports, would be likely to hurt growth. Conversely, if the EU were to lower its own tariffs on imported autos and auto parts, the outlook would brighten, though such a step is likely some way off despite recent speculation. Higher oil prices are also drag on real income growth. And there are signs of emerging capacity constraints in certain member states, including Germany and France. But we reiterate our baseline forecast that the bulk of the slowdown in Eurozone growth from 2017’s blistering pace has now occurred. With financial conditions supportive, employment growth decent and starting to be reflected in higher wages, plenty of room for investment to rise, and fiscal policy set to be a modest tailwind, growth should be maintained at a slightly above-trend rate for the rest of this year. The length and amplitude of the expansion to date certainly don’t point to imminent end-of-cycle risks (see Chart 7).
On the inflation front, Eurozone headline HICP inflation rose to 2.0% in June – only the second time in the past five-and-a-half years that it has exceeded the ECB’s target of below but close to 2%. The increase was driven by energy base effects, which could yet push headline above 2% over the next few months. But upward energy effects will start falling out by the turn of the year, while there are still only limited signs of persistent core inflationary pressures. Indeed, core inflation fell back from 1.1% to 1.0% in June. We forecast core inflation to average 1.1% over 2018 as a whole and 1.3% over 2019. That may be just about enough for an initial ECB rate hike in September 2019, consistent with the ECB’s forward guidance that it does not expect to raise interest rates “at least through the summer of 2019”.