Australia | Sep 28 2009
By Andrew Nelson
If anything, GDP data out of the Eurozone last quarter surprised to the upside. There was only a small contraction of 0.6% reported and this was despite an expectation for a material drop in output. But national performances in the union are continuing to diverge, with some economies improving, but others still showing signs of significant contractions in output, making the recovery path for Europe very hard to pick.
There is no better evidence of this divergence of the prospects of various European economies than the wide spread in GDP forecasts for 2010. Forecasts span the spectrum from positive to negative, and even what is normally a more stable consumer spending component is also fairly diverse.
This leads economists from DBS Bank to predict that while the inventory cycle should show signs of improvement in the current quarter, and 4Q GDP should move to a positive growth number for the region in the fourth quarter, it doesn’t see a trend of domestic demand-led growth emerging until some time next year.
At the earliest, the bank says the second quarter of 2010, but even then its forecasts are for only modest improvements. DBS also questions the normal practice of Europe following the US out of hard time and again, this is due to the big difference if the current economic trends in both regions.
The bank points out that one of the best measures between the two is retail sales, but while US retails sales had risen 1.7% from the beginning of the year to June, the Eurozone’s read was down 2% over the same period.
This trend sees DBS forecast another contraction in European GDP in the first quarter of next year. The bank expects GDP growth to contract by 0.5-0.8% even after booking an inventory led 1.8% growth rate in 2H09. It’s not a big W, but it’s still not the uninterrupted, V-shaped return to growth that the bank sees for other major economic regions around the globe. But after this dip early next year, DBS sees growth momentum returning to a rate above 1%, with much of the early improvement coming from external demand.
Now more than ever the European economy needs exports to drive growth, especially over the next twelve months, thinks DBS. However, the bank believes that a meaningful recovery in exports is still a way off yet. The bank notes that around 20% of European exports come from capital goods and these tend to recover later in the cycle than other exports. This is one of the main differences between the growth prospect for Europe and Asia, with the bank seeing the prospects of the latter as being much brighter in the near-term.
Another issue that might affect export growth is the current and forecast strength of the euro. In August, the euro was up 19% on its 1993-2007 average and in September, its already appreciated another 3% against the US dollar. But as this euro premium unwinds, which the bank thinks it will, the export prospects for Europe will increase.
The is another factor that might have some thinking that European consumer is well set up to enter the fray and pitch in with the recovery. The European personal savings rate is at about 15%, which would lead one to think that the Europe consumer has some money to spend.
However, DBS notes this number isn’t all that it seems. Even though the comparable US rate is in the low single digits, DBS thinks the average European consumer is in a much weaker position. The bank points out that the European economy is fundamentally less dynamic, labour markets are just as weak if not weaker and given a greater shift to part-time jobs, it should take longer for the European consumer to recover.
At the same time, European spending is much more sensitive to a higher cost of living. So even while the bank does expect modest consumer spending growth in 2Q10, there is even greater economic sensitivity and risk to the prospect of a recovery and rebound in commodity prices.
The eventual winding back of government stimulus will also affect the European consumer heavily, and with consumer sentiment still at low levels and with DBS expecting the jobless rate to hit 10.5% by mid-2010, DBS thinks it will be many more months before consumer spending is able to pick up.
One of the biggest problems with the low levels of consumer confidence is the impact it is having on the European banking system. This is especially so as the industry currently instills little confidence given the belief that unlike most other regions, there is still a way to go with balance sheet repair. And weak consumer confidence tends to translate into weak investor demand, which will not only make it tougher for the banks to get the money they need, but will also do little to help investment spending overall.
Weak investment spending means European industry will struggle to keep up with the pace of the current recovery. DBS doesn’t expect to see much improvement in investment spending until the middle of 2010, which not coincidently, is when it sees meaningful economic recovery in the Eurozone.