The Week In The Euro Zone : Is Germany A Spendthrift At Last?

The euro zone recovery looks set to be both gradual and on a modest scale. The OECD’s leading indicator for the euro zone stood at 100.6 in August, up from 100.4 in July. It stands above its long-term average and is at its highest level since July 2011. This trend points to a “gain in growth momentum” but further efforts to put the public finances on a firmer footing, structural reforms and the persistently high level of unemployment continue to drag down domestic demand in most euro-zone countries. In France, the measures to save public money in 2013, including raising taxes, are focussed on the second semester and this should weigh on internal demand. Germany is just in the opposite situation. Returning to budget equilibrium offers rooms of manouever. The Chancellor, Angela Merkel has promised new budegtary spending worth EUR 28 Bn (1 point of GDP) during the electoral campaign. Indeed German activity is more driven by ijnternal demand : in the first half of 2013, the latest contributed positively to growth by 0.4bp, while external trade contribution was negative, which is quite unusual.

Dichotomy between France and Germany ?The data published this week for August seem to be confirming this.

Germany: still top of the class
In Germany, industrial output has bounced back (up 1.4% m-o-m) after declining by 1.1% in July. The detailed figures show that manufacturing (up 2.1% m-o-m) was the main driver of this sharp increase, while production in the energy and construction sectors fell back owing to the high temperatures seen in August. Recent surveys suggest that the recovery in the sector continued into September, albeit at a more modest pace. The IFO index rose slightly on the previous month – its fifth monthly increase in a row. At 53.8, its highest level since January 2013, the composite PMI index remained in an area indicative of economic expansion for the fifth straight month. All in all, industrial output grew by 1.4% q-o-q between June and August. Assuming it remained flat in September (the contraction in industrial orders in August, down 0.3% m-o-m after a fall of 1.9% in July, hints at a small downward correction), it would still be up 0.8% q-o-q in the third quarter. All told, German GDP growth is likely to come in at around 0.5% q-o-q in Q3, after increasing by 0.7% q-o-q in Q2, as it shows a high degree of correlation with activity in the industrial sector. Its contribution to the federal economy has grown over the past decade. It now accounts for 25% of total value-added compared with 23% in 2000. In sum, growth in Germany is likely to run at around 0.8% this year, before accelerating to 1.8% next year.

France: room for improvement
In France, industrial output posted a modest increase in August (up 0.2% m-o-m) after three straight months of declines. As a result, it is likely to contract by more than 1% q-o-q in the third quarter after the sharp rebound in the previous quarter (up 1.2% q-o-q). Growth in France does not track trends in the industrial sector as closely as Germany. The contribution made by manufacturing to the country’s economy has shrunk over the past decade. It now generates just 15% of total value-added. In addition, surveys, though less reliable than in the past, suggest that the economy has moved into a recovery phase. In September, the fresh increase of three points in INSEE’s synthetic business climate indicator augurs well for the future, as does the continuing gradual recovery in household confidence (up 1 point in September), chiefly attributable to their brighter assessment of the outlook for unemployment trends. After the marked rebound in the second quarter (up 0.5% q-o-q), we expect GDP growth to tread water in Q3. The Banque de France is slightly more optimistic. Even so, it has just trimmed its growth forecast for the third quarter from 0.2% q-o-q to 0.1% q-o-q. Although more and more signs of recovery are emerging, unemployment remains high and competitiveness low, and the instability in the tax environment is hardly conducive to a brisk recovery in private-sector investment. Nonetheless, INSEE believes that GDP is likely to move back to its pre-crisis level by the end of the year. We expect GDP growth to be just inside positive territory this year and close to 1% in 2014.

Southern European countries: catching up
Overall, growth in the euro zone is likely to slow down slightly in the third quarter compared with Q2 (0.2% q-o-q in Q3 after 0.3%, based on the latest Q2 estimate published at the beginning of the week). While industrial output slumped in July, giving rise to a negative carry-over for Q3, the stronger level of activity in services should make up for this decline. At 52.2 in September, its highest level since June 2011, the services PMI activity indicator for the euro zone was in expansion zone for the second consecutive month. In addition, surveys suggest that the recovery is not confined to Germany. In particular, the composite PMI indices are moving higher in southern Europe, where they had been on the decline (at 52.8 in Italy, the composite activity indicator is at its highest level since April 2011). Lastly, the European Central Bank remains cautious, acknowledging that a number of risk factors still cloud the outlook for the euro zone. It is expected to leave its benchmark rates unchanged, at least until late 2014, keeping rates in the money market and sovereign debt yield spreads down at a low level–crucial pre-requisites for a sustained recovery in euro-zone economic activity.

BY Caroline NEWHOUSE