RaboResearch - Economic Research

Eurozone economy: A party without cake

Economic Comment

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  • The Eurozone economy grew by 0.2% q-o-q in the third quarter
  • Domestic demand was the main driver, net exports acted as a drag on growth and the manufacturing sector remains in dire state
  • Germany probably contracted by 0.1% q-o-q, making it the weakest link
  • There is not much reason to expect growth to accelerate in the upcoming quarter
  • Spain will continue to top the list while Germany and Italy will likely stay at the bottom

Celebrating a 0.2%

The Eurozone economy grew with 0.2% q-o-q in the third quarter, slightly above consensus expectations of 0.1% q-o-q. Indeed, the third quarter growth figure matches growth in the second quarter, while producer sentiment and hard production data suggested a further slowdown.

We will have to wait until December for an official breakdown by components, but from the available Member States data we can infer that domestic demand has been the main driver of growth. Net exports, unsurprisingly, acted as a drag. Especially private consumption supported GDP growth, on the back of a supportive labour market and upbeat consumer sentiment. Exports are in a bad place due to weak global demand, which is at least partly owing to the US-China trade war. Sector wise, the industrial sector excluding construction likely shrank again, while construction and services supported growth.

Figure 1: Germany expectedly the weakest link
Figure 1: Germany expectedly the weakest linkSource: Macrobond, Eurostat, Rabobank
Figure 2: World trade close to stagnation
Figure 2: World trade close to stagnationSource: Macrobond, CPB, Rabobank

But this party is as good it gets, for now

Looking forward, PMIs and sentiment indicators for October do not give us any reason to expect a substantial growth boost towards the end of the year. In October, the composite PMI for the Eurozone stood at 50.2, i.e. stagnation level, with the manufacturing sector in contraction and the services sector still expanding. The October figure was a notch above the 50.1 posted in September but below the 51.2 average in Q3. At the same time, order books and new orders keep on worsening according to industrial businesses. Currently both are below their long-run averages, although the levels seen during the sovereign debt crisis are still quite some way off. Meanwhile, other surveys indicate that weakening demand is increasingly weighing on production. Especially in the manufacturing sector, and particularly in Germany. The industrial sector clearly remains the weakest link, but the services sector has also lost some of its shine.

From a demand side perspective domestic demand should continue to be supported by employment growth, low inflation (0.7% in October) and low interest rates. That said, employment growth has been slowing and companies expect the slowdown to continue. To be fair, though, average expectations for the Eurozone are very much influenced by the weak outlook in Germany, where expectations suggest employment is actually set to shrink. Nevertheless, at least to some extent businesses across the Eurozone are confronted with weaker (global) demand and profit margins, which are likely to translate into weaker employment growth across the Eurozone. This hampers consumption growth, especially in those countries where households cope with very low saving rates, most importantly Southern Eurozone Member States.

Finally, the US – China trade war, the lingering threat of US tariffs on European cars and the uncertain Brexit outcome are not very helpful for the Eurozone growth outlook either. Their (potential) impact differs quite substantially between Member States, though.

Figure 3: Weakness mainly in manufacturing
Figure 3:  Weakness mainly in manufacturingNote: PMI is Purchasing Managers Index. A value above 50 suggests output in the economy/specific sector is growing. A value below 50 suggest output is contracting.
Source: Macrobond, Markit, Rabobank.
Figure 4: Consumers are still rather upbeat
Figure 4: Consumers are still rather upbeatNote: ESI is Economic sentiment indicator.
Source: Macrobond, Eurostat, Rabobank

Germany, the Eurozone’s party pooper

While we do not have an official growth figure for Germany yet, it is clear that it was the Eurozone’s weakest link. We expect the German economy to have contracted for the second time in a row by 0.1% q-o-q. With a meagre +0.1% q-o-q, Italy also underperformed, again. Spain (0.4% q-o-q), Belgium (0.4% q-o-q) and France (0.3% q-o-q) on the other hand were the Eurozone’s bright spots. While Spain has become accustomed to such growth rates over the past years, for France the position is quite new. As mentioned, for Germany we don’t have any official insights yet, but in all the other countries domestic demand, mainly private consumption, was the driving force, while net exports contributed negatively to the headline figure.

Despite some common developments and threats, we believe that the growth differences that were visible in the past few quarter will continue to persist. With Spain topping the list and Germany and Italy underperforming with growth rates around 0% q-o-q in the short term.

The German economy is among the most vulnerable to weakness in global demand and trade tensions. As we expect these tensions to persist, we believe German exports will remain under pressure, which means that a clear recovery in the manufacturing sector is still far off. The risk being that in due time, manufacturing weakness will drag the services sector down as well.  From a demand side perspective private consumption is likely to continue to provide support on the back of all-time low unemployment and higher wage growth. But for now this will be insufficient to fully compensate for weak (net) exports.

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