Senior European Economist—Global Economic Research
Recent data suggest that the euro area remains in a relatively mild recession, defying expectations of a much deeper downturn.
This is no small feat in the circumstances. But there is no sign of a positive catalyst, and tail risks are still heavily skewed to the downside.
July survey data suggest that the euro-area economy entered the third quarter in much the same way that it ended the second. At least that’s the message from the composite Purchasing Managers’ Index (PMI) and new-orders component of the manufacturing PMI, both of which have moved broadly sideways in recent months. These key cyclical indicators are consistent with contracting output, but at a relatively modest pace and roughly in line with expectations.
Still, there is little scope for complacency. On the contrary, there are a number of reasons to remain very cautious on the outlook for euro-area output growth.
The first is that the aggregate PMI data conceal some worrying developments in individual countries. For once, this is not about the periphery, where the composite PMI has been surprisingly resilient in recent months. These countries are still in deep recession, but there is no evidence of the broad-based collapse that overwhelmed the Greek bailout program.
Rather, it is about Germany, where the PMIs have moved sharply lower in recent months. In July, the composite PMI fell to 47.3 from 48.1 in June, while the new orders component of the manufacturing PMI dropped to 42.4 from 43.8. The latter is now at its lowest since April 2009.
Part of this deterioration was to be expected. Last week, we argued that Germany is in better shape than (most of) the rest of the euro area. But this does not mean its economy is immune to developments elsewhere. Problems in the periphery have hurt Germany in two ways. First, uncertainty related to the sovereign debt crisis has had a negative impact on capital spending, which is now moving sideways even though domestic fundamentals remain sound. Second, German exports to the periphery have collapsed.
But Germany is also a big exporter to the outside world (more than 60% of German exports are to non-euro-area countries). Until recently, this had been a source of considerable strength, with factory orders from countries outside the euro area continuing to rise rapidly, more than offsetting the weakness in orders from the rest of the euro area. But hard data in this area are only available up to May. If the recent weakness in the German manufacturing PMI is an indication that global growth is slowing more rapidly than anticipated, it will be a source of some concern. As was demonstrated vividly in late 2008 and early 2009, Germany’s position as a major capital-goods exporter means it is almost uniquely exposed to downturns in the global investment cycle.
No Sign of an Imminent Upturn
Our second concern is that even though the recession remains relatively mild—at least at the aggregate level— there is still no sign of when it might end. That is not to say that there aren’t grounds for hope. As we have argued before, 2012 is likely to be the peak year for austerity in the euro area, with much less fiscal tightening due to be applied next year. Moreover, the recent depreciation of the euro—now at its lowest since 2002 on a trade-weighted
Basis— is a positive development which, at a minimum, should help shelter euro-area exporters from the full force of any slowdown in world trade growth.
Nonetheless, it is still difficult to identify how or when the economic situation will start to improve. Part of this is related to the breakdown of the monetary transmission mechanism in large parts of the euro area. But it also reflects the failure of governments to draw a line under the sovereign-debt crisis and the impact that the resultant uncertainty is having on capital spending decisions in core countries like Germany.
This leads directly to the final reason for caution: the next few months are littered with downside risks. These include the risk that Greece might leave the euro and the possibility that Spain and Italy could lose market access at a time when the existing support mechanisms are not big enough to rescue them At best, uncertainty on these and other issues will continue to weigh on capital spending. At worst, some of these risks might crystallize, with very damaging consequences.
So where does this leave us? At the end of last year, we took the view that the euro area would experience a relatively mild recession this year rather than the deep contraction feared by some observers. So far, this view has been correct, with massive liquidity injections from the European Central Bank (ECB) helping to prevent a much worse outcome.
The bad news is that we are not much further forward. The economy is likely to contract again in the current quarter, and our earlier hopes for a stabilization in the fourth quarter now look optimistic—especially if global growth slows more quickly than expected. Moreover, risks to the outlook are still heavily skewed to the downside.
That the euro area has so far managed to avoid a deep economic contraction is, in our view, no small feat. It is also one that policymakers need to capitalize on. In this respect, a recent speech by ECB President Mario Draghi promising to do“whatever it takes to preserve the euro” is a welcome development. But it needs to be followed
by decisive action from the central bank and politicians if we are to look forward with greater optimism.
The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. Alliance-Bernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates.
Note to Singapore Readers:This document has been issued by AllianceBernstein (Singapore) Ltd. (Company Registration No. 199703364C). The Company is a holder of a Capital Markets Services Licence issued by the Monetary Authority of Singapore to conduct regulated activity in fund management and dealing in securities.
Note to Hong Kong Readers:The document has not been reviewed by the Securities and Futures Commission. The issuer of this document is AllianceBernstein Hong Kong Limited.