EU Area
Growth shifted into a lower gear in the second quarter. An adverse external environment caused exports to flatline, while household spending lost momentum amid downbeat confidence and diminishing returns to job gains. Data for Q3 suggests that the economy remains stuck in a soft patch and continues to be defined by divergent dynamics in the export-oriented manufacturing sector and the services sector. Industrial production recorded its fourth drop in five months in July and the manufacturing PMI remained in contractionary territory in August, underscoring the sector’s persistent weakness. Conversely, the services PMI rose further into expansionary territory in the same month. Amid soft dynamics, the ECB unveiled a broad stimulus package in September to kick-start activity. However, given already ultra-accommodative conditions, it appears unlikely that it will notably shore up the outlook. Consequently, ECB President Mario Draghi also called on governments with fiscal space to unleash stimulus and some officials are starting to respond.
Headwinds from slowing global growth, trade war uncertainties and issues in the manufacturing sector are seen dragging growth to an over five-year low in 2019. Next year, momentum is expected to be broadly unchanged. Slowing activity in China is expected to weigh on exports, while investment is seen staying soft. Risks linger from trade tensions, a no deal-Brexit and politics. Growth is seen at 1.1% in 2019 and 1.1% again in 2020, which is down 0.1 percentage points from last month’s forecast.
The euro hovered around the lowest levels seen since mid-2017 in September. On 19 September, the currency ended the day at USD 1.11 per EUR, a 0.4% depreciation from the same day in August. Waning economic momentum, muted inflation, ultra-accommodative monetary policy and trade uncertainties have kept the euro weak and these factors are seen lingering ahead. Our panel sees the euro ending 2019 at USD 1.12 per EUR and 2020 at USD 1.16 per EUR.
Growth Sinks
A third estimate confirmed that the Eurozone economy lost traction in the second quarter, suppressed by a weaker performance from both the domestic and external sides of the economy. According to Eurostat, GDP increased a seasonally-adjusted 0.2% in Q2 from the previous quarter, half that of Q1’s 0.4% expansion. Q2’s reading was unchanged from the two flash estimates and marks one of the slowest readings in the past four years. Household spending growth decelerated to 0.2% over the previous quarter in Q2, from Q1’s 0.4% and driving the slowdown in the domestic economy. Diminishing gains in the labor market and lower confidence likely contributed to the slowdown. On a brighter note, fixed investment growth accelerated from 0.2% in Q1 to 0.5% in Q; government consumption, however, slid from 0.4% growth to 0.3%. The external sector subtracted marginally from growth in the quarter as exports growth stalled. Exports growth flatlined in Q2, amid a subdued global economy and overall adverse external environment (Q1: +0.9% quarter-onquarter). Import growth also slowed, coming in at 0.2% in Q2, from 0.4% in Q1. Compared with the same quarter of 2018, seasonally-adjusted GDP rose 1.2% in Q2, slightly below Q1’s 1.3%. The ECB sees the Eurozone economy growing 1.1% in 2019 and 1.2% in 2020. FocusEconomics Consensus Forecast panelists expect the Euro area economy to expand 1.1% in 2019, which is unchanged from last month’s forecast. For 2020, panelists also expect the economy to grow 1.1%, which is down 0.1 percentage points from the previous month’s estimate.
Composite PMILeading indicators point to slightly improved dynamics in August in the Euro area’s economy. The Flash Eurozone Composite Purchasing Managers’ Index (PMI), produced by IHS Markit, came in at 51.9, up from July’s 51.5. That said, the reading still marked one of the worst results in the past six years. The PMI lies just above the 50-point threshold that distinguishes expanding business activity in the Eurozone. The details of the release revealed a continued two-speed Eurozone economy. The manufacturing PMI came in at 47.0 in August, up from July’s 46.5 but still signaling contractionary conditions in the sector. Manufacturing output fell for the seven consecutive month and firms shed jobs once again. In contrast, the Services PMI Activity index edged further into expansionary territory in August, coming in at 53.4 (July: 53.2). On a sour note, confidence dropped sharply in August across both sectors. Regarding the Eurozone’s two largest economies, both France and Germany’s composite PMIs edged up in August. However, while France’s manufacturing PMI returned to growth territory, Germany’s continued to point to contractionary conditions. Elsewhere in the region, activity was broadly stable. FocusEconomics Consensus Forecast panelists expect fixed investment to grow 2.6% in 2019, which is unchanged from last month’s forecast. For 2020, panelists see fixed investment increasing 1.6%, which is down 0.2 percentage points from last month’s projection.
Industrial Output continues To DragIndustrial output contracted once again in July, recording the fourth drop in five months. Industrial production fell a seasonally-adjusted 0.4% over the previous month, a softer drop than June’s revised 1.4% decrease (previously reported: -1.6% month-on-month). June’s result had marked the worst reading since September 2018. July’s result undershot market expectations of a mild 0.1% fall. Energy, intermediate goods and non-durable consumer goods output all contracted in July, driving the fall. However, rebounds in capital goods production and durable consumer goods output softened headline figure.
Monetary Policy Changing
The European Central Bank (ECB) unveiled a broad package of stimulus at its meeting on 12 September, in order to revive growth and inflation in the downbeat Eurozone economy. The ECB decided to cut the deposit rate by 10 basis points deeper into negative territory, announced it was restarting quantitative easing, opened up its forward guidance, along with other changes to targeted longer-term refinancing operations (TLTRO III) and reserve remuneration. At large, the measures represented slightly more stimulus than market analysts had expected. Accordingly, the deposit rate now sits at a new record-low of minus 0.50%, while the other main interest rates are unchanged: the refinancing rate at 0.00% and the marginal lending rate at 0.25%. The Bank’s asset purchase programme (APP) will be restarted on 1 November, at a pace of EUR 20 billion per month, slightly below market analysts’ expectations. However, notably, the APP was left open-ended, with President Mario Draghi stating in the accompanying press conference that it will run “for as long as necessary to reinforce the accommodative impact of our policy rates”. Adding to the accommodative measures, the Bank stated it will reprice its TLTRO III’s and include an incentive for banks to increase lending. Moreover, the Bank will introduce a two-tier system for reserve remuneration, which should further support monetary policy transmission and reduce pressure on banks’ lending margins. Soft economic data, persistently low inflation, modest inflation expectations and ample downside risks to the outlook drove the ECB to unleash the shot of stimulus to shore up prospects. While, all-in-all, the measures should loosen monetary conditions and boost activity, it remains to be seen, however, if it will be enough to improve the outlook. A weak industrial sector, a less favorable global backdrop and geopolitical concerns have hampered growth in recent quarters and are seen continuing to plague the outlook ahead.
