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Monday, May 5, 2008

Jitters In The Eurozone?

by Edward Hugh: Barcelona

Economic confidence across the eurozone has now started eroding steadily, with increasing signs that the growth slowdown is hitting the region’s manufacturing output and labour market, according to a number of indicators we have been seeing in recent days.

The European Commission’s eurozone “economic sentiment” index fell notably last month, dropping from 99.6 in March to 97.1 in April – the lowest level since August 2005. With the indicator regarded as good guide to growth trends, the reasonably steep decline pointed to a marked deceleration in economic activity, a deterioration which we are also seeing on other fronts like retail sales. If we look at the overall confidence indicator chart we can see that things have now been deteriorating steadily since last summer.

The latest data will undoubtedly add to speculation that the European Central Bank will cut interest rates later this year (although they are virtually certain to leave things untouched this week). This will be doubly the case since eurozone inflation shows signs of slowing, and Eurostat reported in a flash estimate at the end of last week that eurozone prices rose at an annual rate of 3.3 per cent in April – down from 3.6 per cent in March – suggesting that the worse may be over in terms of price pressures.

The picture, however, is a mixed one. The german economy - despite some recent evidence of weakening in the labour market dynamic - has been holding its head above water, as has the French while, as can be seen from the above chart, Italy's economy continues - like Venice - to sink steadily, and the two eurozone economies which had the strongest housing booms - Spain and Ireland - head steadily off the cliff, with Spain occupying poll position, and by quite a long margin.

Manufacturing PMIs

European manufacturing growth slowed for a third month in April as cooling global demand and a stronger euro took their toll on export orders. Royal Bank of Scotland Group Plc's manufacturing index fell to 50.7 from 52 in March, according to NTC Economics Ltd., which carries out the survey of purchasing managers. That's less than an initial April 23 estimate of 50.8 and the lowest since August 2005. A reading above 50 indicates growth.

The final RBS/NTC Eurozone Manufacturing PMI came in at 50.7 in April, down from 52.0 in March and slightly below the earlier flash estimate of 50.8. The fall in the PMI was the largest for six months and took the index to its lowest since August 2005.

German PMI

German manufacturing activity weakened to its slowest pace in four months in April, but held above its long-term average thanks to robust expansion in output. A dip in new orders growth, however, suggested pressure on output may increase in coming months and the pace of job creation slowed to the weakest since October.

The NTC/BME Purchasing Managers' Index (PMI), based on a survey of 400 firms, slipped to 53.6, adjusted for seasonal swings, from March's seven-month high of 55.1, NTC said.

"The manufacturing sector remained on a healthy footing at the start of the second quarter, with production rising at a robust and above-trend rate," said NTC economist Tim Moore. "However, output growth was again slower than the peak of the current growth cycle and will likely come under pressure in the months ahead following the relatively subdued improvements in new order volumes recorded on average in 2008."

A measure of output rose to 55.3 in April from 54.7, NTC said. By contrast, a gauge of employment fell to 54.2 from 56.5 and a measure of new orders dropped to 52.5 from 54.9.

An NTC gauge of new export orders signalled the second-weakest increase for around three years, falling to 51.8 from 54.0.

"There were reports that the strong euro and deteriorating economic conditions in the United States had both weighed on export demand," the group said. NTC chief economist Chris Williamson said the impact of the strong euro was most discernible in the consumer goods sector in April's survey. "Whether that's down to the euro or just general easing of consumer sentiment in key trading partners like Britain and the United States remains to be seen," Williamson said. "There are problems in competitiveness creeping in because of that strong euro on a broadbased scale," he added. On prices, Moore said a surge in steel and energy costs had underpinned a sharp increase in average cost burdens last month, with the rate of inflation only just below March's eight-month high. "April data suggest that the spike in pipeline inflationary pressure has begun to make its way to the factory gate, as output prices rose at the third-strongest pace in the series history," Moore added


Shrinking orders and slowing output caused French manufacturing growth to fall to its weakest level in six months in April.
The NTC/CDAF Purchasing Managers' Index (PMI), came in at 51.1, below March's 51.9 and under the flash estimate and economists' forecasts of 51.5. The index reading added weight to recent data showing a French economy was slowing, even if not as rapidly at this point as some of the other members of the eurozone.

"It looks increasingly possible manufacturing could contract... It all very much depends on factors like the strength of the euro and global demand," said Chief Economist Chris Williamson at data compiler NTC. "We could see some negative figures this autumn... consumers just aren't buying, and the consumer goods industries already reported output contraction in April."

New work placed with French manufacturers contracted for the first time since last September, with the new orders index falling to 48.6 from 50.1 in March.
Output growth slowed, slipping from 53.4 in March to 53.1, well below the long-run average of 54.9. Rising prices led French consumers to cut back in March, and monthly spending fell by its sharpest rate in a year and a half. In April, household confidence dropped to its lowest level in over two decades.

NTC's Chris Williamson said fading demand could affect unemployment, which has been on a downward trend since 2005.

"I think we'll see some modest cuts in employment and net job losses, like we saw at the end of last year, going through to the third quarter," Williamson said. "But French manufacturers have been very conservative in their hiring, especially compared to German and Spanish manufacturers... so that suggests they're lean already and may not need to focus so much on reducing staff costs," he added

This basically slowing but "neutral" call on France can be observed in the EU economic sentiment indicator, which is still holding up tolerably well under the circumstances.


Italy's manufacturing sector contracted for a second month in April, posting its weakest performance since May 2005 and casting a deepening shadow over growth prospects, accoring to the NTC/ADACI PMI survey.

The NTC Purchasing Managers Index fell to 48.2 from March's 49.4, sinking further below the 50 divide between growth and contraction. The survey is the latest in a string of negative data for the euro zone's third largest economy, underscoring the tough task awaiting incoming Prime Minister Silvio Berlusconi after his victory in last month's general election.

"There are really no indications of a turnaround, with backlogs of work still falling and new orders the weakest since December 2001," said Chris Williamson, chief economist at NTC Research which compiles the data.
"The big area of weakness in Italy is in the domestic economy, and within that the consumer sector where things are going form bad to worse."

The International Monetary Fund forecasts the Italian economy will grow just 0.3 percent this year, and Williamson said the PMI data pointed to a contraction of gross domestic product in the first and second quarters, and possibly beyond.

"These PMI figures are very much signs of recession," he said, forecasting that the rate of job losses is likely to pick up, hitting consumer confidence further. Italy's 1.5 percent 2007 growth rate was little more than half the euro zone average, maintaining a trend of Italian underperformance that has persisted for at least a decade.

The survey showed employment levels fell for the third month running and the manufacturing output sub-index pointed to a fall in output for the first time since May 2005. Input price inflation eased significantly to a four-month low but, with an index level of 64.2, remained at a high level by historical standards.


Spain's manufacturing sector shrank at its fastest rate in more than six years in April and more hardship seems to be on its way as orders continued to dry up. Spanish economic growth is expected to halve this year from last year's rate of 3.8 percent as property sales plunge, the construction sector shrinks, loan defaults rise, and unemployment surges.

The NTC Purchasing Managers Index (PMI) showed the gloom had settled firmly over the manufacturing sector which shrank for the third month in a row, dropping from 46.4 in March to 45.2 in April, its lowest in 76 months and well below the 50-mark that separates growth and contraction.

The new orders index dropped to 42.0 from 45.3, which NTC put down to weaker demand from the building sector and foreign buyers put off by the strength of the euro. Export orders dropped at the fastest rate in almost five years.

"The continuing strength of the euro and worsening global economic conditions suggest external demand is unlikely to fill the void left by the end of the construction boom." said Nathan Carroll, an economist at NTC.

Employment slipped for the eighth month running and at the sharpest rate for three years at 47.7 as manufacturers tried to cut costs and make up for lower orders.
That might put in doubt government predictions that industry can provide new jobs for those who have been laid off from the construction sector.

"I suspect that these numbers will provide some worrying reading for anyone thinking that the manufacturing sector can absorb jobs from construction ... employment is falling for the eighth month running and the indications are that companies are going to cut back further," said Chris Williamson, chief economist at NTC. "The long term trend in employment is difficult to say ... but would we expect to be seeing job losses in industry in the INE survey in coming quarters? Yes."

So What Happens Next?

My basic guess is that the mechanism for the biggest chunk of the slowdown in the eurozone will come from events in central and eastern europe, and in one of those peculiar but fascinating circular causality processes the crunch in Eastern Europe will come via a slowdown in Germany. Basically the German economy is very heavily dependent on exports (see numerous posts on this blog), and German GDP growth is now very sensitive to export volume growth. The slowdown in the UK, Italy and Spain - which are all important German customers will in all likelihood have a significant negative impact on the German industrial output dynamic, and we saw an indication of this in the relatively weak employment growth in April in Germany. Since most of the CEE is locked into the German economy quite strongly this loss of momentum in the German economy will be felt across the zone, and in a sort of negative lose-lose dynamic this impact on output in the CEE will work its way back home to Germany again. That is to say I would be expecting to see quite a significant slowdown in Germany in the second hallf of 2008. And when we get a big slowdown in Germany the last leg will fall from under this current wave of expansion in the eurozone, in my humble opinion.