The European Central Bank (ECB) left its monetary policy stance unchanged at its September 13 meeting. Net asset purchases will end in December, but with the Bank’s maintaining its stock of assets, the reinvestment of redemptions will maintain substantial stimulus. No increase in policy interest rates is signaled until at least after the end of next summer. Note that the main ECB refinancing rate is still zero. Attention, therefore, focused on the updates of the ECB staff’s macroeconomic forecasts as presented by ECB President Mario Draghi. The Bank’s assessment of the economy is upbeat, viewing the expansion as ongoing and broad-based. The economic growth projections reflected very small downward revisions. GDP growth for the current year is now forecast at 2.0% instead of 2.1%. Growth in 2019 is forecast to be 1.8%, also a reduction of 0.1% from the previous projection. The moderation from the 2.5% pace in 2017 is due mainly to a weakening of global trade, while domestic demand remains strong.
The Eurozone Purchasing Managers’ Index (PMI) for August continued to indicate a robust economy but one with a growing imbalance. Growth accelerated in the two largest economies, Germany and France, while Italy, the third largest, experienced a sharp growth slowdown, and Spain also looks weak. A disturbing development is that business confidence concerning future activity has declined to its lowest level in 23 months. For Italian and Spanish companies, expectations are at a five-year low. Global trade tensions and political uncertainties, including the difficult BREXIT negotiations and the battle in Italy over the budget, are undermining confidence.
The positive factors cited by Draghi as underlying the ECB’s upbeat analysis related to the underlying strength of the domestic economies in the region. These factors include the continuing monetary stimulus, record-low interest rates, a more positive fiscal stance, and the strength of the labor market, with healthy employment growth and rising wages that are fueling consumer demand. Draghi argued that the strength of the economy balances the downside risks from global factors. He also offered assurances with respect to Italy, noting that the rise in Italy’s borrowing cost did not spread to other member states, and the cost has recently declined.
Downside risks to the outlook were underlined last Friday, September 21, by the release of the Flash Eurozone PMI for September. The drop in this statistic to a 4-month low, according to preliminary data, indicates that Eurozone manufacturing-sector business activity is growing in September at the second weakest rate since late 2016. The slowdown is said to be due to a stagnation of exports. New orders were the weakest since October 2016. Trade war concerns and reduced global demand, notably in the auto sector; increased risk aversion; and political uncertainties, both within the Eurozone and globally, were all cited as factors. On the positive side the service sector is continuing to experience buoyant growth and strong job gains. Also, despite the current slowdown, business optimism about future activity ticked up somewhat from the gloomy August levels.
Eurozone equities are recovering from declines earlier in the year and so far have been shrugging off the negative concerns cited above. The comprehensive iShares MSCI Eurozone ETF, EZU, while still down 3.2% year-to-date, is up 1.06% over the past three months and has gained 3.10% over the past five market days through September 21. The decline in the euro versus the US dollar earlier this year (still down 2.7% year-to-date) accounts for much of this performance for dollar-based investors. The equity market of the largest Eurozone economy, Germany, has been underperforming in the region but is finally getting a bid. The iShares MSCI Germany ETF, EWG, is still down slightly over the past three months, -0.23%, but is up 2.96% over the past five days. The French market has been outperforming most of its neighbors, with a positive year-to-date return for the iShares MSCI France ETF, EWQ, of 1.83% and a three-month return of 3.11%. The equity markets of Italy and Spain, despite the current concerns about their economies and political uncertainties, are performing strongly, with the iShares Italy ETF, EWI, rising 4.29% and the iShares Spain ETF, EWP, up 3.87% over the past five days. We are maintaining market-weight positions for the Eurozone in our International Portfolios.