Euroland lead indicators have turned down again, threatening to scupper the economic recovery that never really was. We have been, relatively speaking, ‘bullish’ on Euroland growth for a little while now – based partly on the ‘surely it can’t get much worse’ theory of economic forecasting. This week’s batch of miserable indicators shows that it still can get worse, but we still believe there is a huge degree of concentration on the gloom, which risks overlooking some of the more positive Euro Area developments that have already takeplace and which should continue to contribute to a steady (and very slow by Anglo-Saxon standards) domestic expansion.
The main lead indicator of Euroland activity is the German IFO survey. After spending about a year operating within a pretty narrow range – and one which was consistent with a mediocre expansion – the past two months has seen the index decline more meaningfully. Sentiment towards the growth prospects for Euroland have dipped accordingly, with the euro being the most prominent casualty in recent weeks, tracking back to a seven-month low versus the US dollar of 1.25. That said, some of this move is likely to have been a reflection that the market had expected a ‘non’ vote in last Sunday’s French referendum on the EU constitution, though such an effect would unwind soon.
For our own part, we need to decide whether the recent downside data surprises are sufficient for us to change our view on the long-held notion that some domestic recovery is likely to endure. For the time being, it is hard to argue that very much has fundamentally changed. Certainly, the domestic expansion remains fragile, but as this week’s French consumer spending data (April up 1% mom and March revised up by 3/10ths) showed, it is still moving forward. And it is worth pointing out that French spending growth has surprised to the upside in 5 of the past 6 months. Unfortunately, for the durability of the recovery, this has been driven mostly by credit and not income growth. On the jobs side of things, the situation is still pretty stationary across the region. The best that can be said here is that the worst seems to be over in terms of the German real wages drop, which troughed at the turn of the year.
The bottom line is that the Euro Area recovery continues to tread water. Downside risks have grown, courtesy of more depressed sentiment on the prospects for global growth (and how that might affect Euroland) but we think these downside risks are limited by an external economy that is decelerating rather than collapsing. In our view the most likely outturn for Euroland in an aggregate sense is a continuation of a very slow-paced recovery.
By Steven Andrew, economist,F&C Asset Management