Deflation Worries Persist; Outlook Weakens Amid Slowdown in Germany
Developed Europe remained bogged down by deflationary conditions all through the third quarter. Annual inflation in the region’s 18-member single-currency bloc, the Euro-zone, slipped from 0.4 percent in July to 0.3 percent in September, its lowest level since October 2009. Euro-zone inflation has been declining consistently since October 2011 and has in fact stayed below 1 percent for more than a year now. So, understandably, the continued fall in inflation during the third quarter intensified concerns that weak consumer demand and excess capacity in the economy are pushing the Euro-zone into a deflation trap, or a period of stagnant or falling prices that stymies investment, curtails consumption, and makes it difficult to pay off debt.
Under pressure to prop up inflation through monetary measures, the European Central Bank (ECB) cut interest rates to record lows and launched a bond-buying program in early September. As a part of this initiative, the ECB will buy certain categories of securities from Euro-zone banks, which in turn is expected to add liquidity to the financial system, increase bank lending, and boost economic activity. However, given that the current rate of inflation stands close to zero and substantially below the ECB’s target of just under 2 percent, there is growing clamor for the central bank to begin buying government bonds too and embrace full-fledged quantitative easing (QE), just as the U.S. Federal Reserve and Bank of Japan have done in the past.
However, the ECB has so far resisted a “full-blown QE” partly due to Germany’s objections to such a move and because it believes the bond-buying program launched in September will show results soon. In other developments, the growth outlook for the Euro-zone remained subdued in the third quarter because, among other factors, Germany reported a number of disappointing data during the period. Germany has a sizeable influence on the Euro-zone economy as it accounts for nearly a third of the currency bloc’s GDP and German imports drive economic activity in various parts of the bloc.
Moving into the fourth quarter, Developed Europe has witnessed two key events. In a step that is being described as the first pillar of a banking union for the region, the ECB has started regulating all European banks. But more importantly, the stress tests and Asset Quality Reviews the central bank recently conducted on more than 120 regional banks before beginning its new banking supervisory role have revealed a largely positive picture of the Euro-zone banking system. Only about 25 banks failed the tests and nearly half of them have already taken the steps to correct their failings.
At a Glance
Germany:After shrinking 0.2 percent in the second quarter, the German economy reported more bad news during the third quarter. In August, its exports plunged 5.8 percent from July in seasonally adjusted terms and the manufacturing sector, which produces a sizeable part of the goods the country sells overseas, saw industrial output decline 3.1 percent. The government cut growth forecasts for 2014 and 2015.
U.K.:According to preliminary estimates, GDP expanded 0.7 percent during the third quarter. Given that the second quarter had seen a faster pace of growth (0.9 percent), the latest data added to concerns that Britain has been mildly affected by the slowdown in the neighboring Euro-zone, its biggest trading partner.
France:According to preliminary estimates, GDP inched up 0.1 percent-0.2 percent in the third quarter compared to the second quarter. The unemployment rate remained in an uptrend during the review period, rising to 10.5 percent at the end of September.
Italy:The Bank of Italy believes that the Italian economy likely contracted again and remained in recession during the third quarter. In August and September, the annual rate of inflation slipped to -0.1 percent and -0.2 percent respectively, emphasizing the severity of the weakness in the Italian economy.
Spain: According to preliminary data, Spanish GDP expanded 0.5 percent compared to the second quarter and 1.6 percent compared to the same period a year ago. The unemployment rate, which is the second highest in the Euro-zone after Greece, fell from 25.7 percent a year ago and 24.5 percent in the second quarter to 23.7 percent at the end of September, its lowest level since 2011.
GERMANY: WEAK EXPORTS DATA EXACERBATE SLOWDOWN WORRIES
After shrinking 0.2 percent in the second quarter, the German economy reported more bad news during the third quarter. In August, its exports plunged 5.8 percent from July in seasonally adjusted terms. Not surprisingly, the manufacturing sector, which produces a sizeable part of the goods Germany sells overseas, saw industrial output decline 3.1 percent in August. In September, though, industrial output recovered modestly but not to the extent analysts expected. Similarly, industrial orders inched up a meager 0.8 percent in September after dropping 4.2 percent in August. Reflecting the weak outlook for exports, the Munich-based Ifo Institute’s measure of business confidence in Germany remained in a downtrend all through the third quarter.
It is commonly believed that despite being a fundamentally robust economy with a record-low unemployment rate, a flexible workforce, and a strong fiscal position, Germany is struggling in the wake of diminished demand for its exports in key foreign markets. The Euro-zone, which receives nearly 40 percent of Germany’s exports, has had an inconsistent recovery for several quarters now. Alongside, China, which typically buys 6 percent of the goods Germany sells overseas, has reduced investments in capital goods, which Germany produces in large quantities, to focus more on improving domestic consumption. Russia, which purchases 3 percent of German exports, has been hit by sanctions and low oil prices. Given these adverse conditions, the German Economy Ministry has slashed its GDP growth forecast from 1.8 percent to 1.2 percent for 2014 and from 2.0 percent to 1.3 percent for 2015.
Understandably, several Euro-zone national governments and policy makers are worried about the muted prospects of the currency bloc’s primary growth driver, more so because Berlin, despite acknowledging the situation, has so far steadfastly refused to adopt any monetary or fiscal stimulus measures to support its economy. In fact, according to media reports, there is growing pressure on Germany not just to stop objecting to a “full-blown QE” by the ECB but also to increase government spending in sectors such as infrastructure. Still, Berlin has signaled that it considers the current slowdown temporary and moderate.
THE U.K.: RECOVERY CONTINUES, ALBEIT AT A SLOWER PACE
According to a preliminary estimate by Britain’s Office for National Statistics (ONS), GDP in the country expanded 0.7 percent during the third quarter. Given that the second quarter had seen a faster pace of growth (0.9 percent), the ONS forecast has added to concerns that Britain has been mildly affected by the slowdown in the neighboring Euro-zone, its biggest trading partner. Nonetheless, to put these data in perspective, the U.K. economy has been advancing rapidly and consistently since mid-2013, when it ended a long phase of slow growth and stagnation. And, despite a comparatively subdued performance in the third quarter, Britain appears on track to clock this year’s fastest pace of growth among developed countries, as the IMF has predicted.
What’s more, the third-quarter data also revealed what appears to be a much-needed rebalancing in the economy. Britain’s strong recovery over the past few quarters has been driven primarily by the services sector, which accounts for nearly 80 percent of the economic activity in the country, while the much smaller manufacturing and construction sectors have lagged behind. But in the latest quarter, manufacturing and construction activity grew faster than overall GDP while the pace of services sector growth moderated. If manufacturing and construction continue to gain momentum in the coming quarters, Britain’s recovery would likely become more broad-based and a bit less dependent on consumer spending.
The rate of annual inflation in the country remained in a downtrend throughout the third quarter, plunging to a five-year low of 1.2 percent in September. Given that this rate is significantly below the Bank of England’s target rate of 2 percent, speculation that the central bank may raise its benchmark interest rates in early 2015 has weakened significantly and there is a growing belief now that a rate hike is unlikely before summer next year. Low interest rates should stand Britain in good stead during the coming quarters as the outlook for exports has deteriorated significantly amid the global slowdown, and the country will likely have to continue depending on domestic demand for growth.
FRANCE: PRIVATE SECTOR OUTPUT DECLINES AS BUSINESSES REMAIN UNDER PRESSURE
Following two successive quarters of stagnant growth in the first half of the year, French GDP likely expanded marginally during the third quarter. France’s central bank has estimated that between July and September, GDP inched up 0.2 percent compared to the second quarter while the country’s statistics office INSEE has pegged the growth rate at 0.1 percent. In any case, the third quarter turned out to be another disappointing one for the country. France’s unemployment rate remained in an uptrend during the period, inching up to 10.5 percent at the end of September. In fact, September saw the French private sector cutting jobs at the quickest pace in 16 months, signaling that companies likely expect a prolonged slowdown in the country. In sync with the unemployment numbers, consumer spending plunged 0.8 percent between August and September. Analysts expected the number to decline only 0.1 percent.
Adding to the discouraging news, data compiler Markit has declared that the services sector, which accounts for more than half of France’s economic activity, contracted in September after growing in July and August. French manufacturers though saw their foreign orders dropping in all three months of the third quarter. Given the setback in both manufacturing and services activity, the country’s combined private sector output remained in a downtrend through the third quarter.
Seen in its entirety, the private sector’s third-quarter performance reflects the severity of the problems French businesses are facing now. On the one hand, the demand for French exports has weakened due to the global slowdown and the declining competitiveness of French goods in the global marketplace. On the other, domestic spending has remained subdued owing to high unemployment. In such an operating environment, the problems of French firms have been exacerbated by a rigid labor market and a stringent tax system.
ITALY: ECONOMY REMAINS IN RECESSION; INFLATION SLIPS INTO NEGATIVE TERRITORY
The Bank of Italy believes that the Italian economy likely contracted again and remained in recession during the third quarter. According to the central bank, falling investments and exports played the biggest role in the output contraction. Indeed, data published by Italy’s National Institute of Statistics (ISTAT) show that the value of goods exported from the country plunged from 38.6 billion euros in July to 24.1 billion euros in August. Similarly, in line with the Bank of Italy’s GDP forecast for the third quarter, industrial production plummeted 0.9 percent between August and September. Compared to the same period a year ago, industrial production showed a steep decline of 2.9 percent.
Nevertheless, ISTAT’s inflation numbers were the most discouraging data Italy reported for the third quarter. In August and September, the annual rate of inflation slipped to -0.1 percent and -0.2 percent respectively, emphasizing the severity of the weakness in the Italian economy. More importantly, the data compounded the deflationary concerns around the Euro-zone by bringing into question the efficacy of the ECB’s latest monetary measures. Despite ultra-low interest rates and many ECB initiatives to boost bank lending, Italy has slipped into recession three times since the beginning of the financial crisis in 2008. With this, many economists and analysts have expressed worries about whether the ECB’s latest bond-buying program is adequate to jumpstart growth in troubled countries such as Italy, which have been bogged down by structural problems and huge debts.
On a more positive note, September saw the Italian Prime Minister Matteo Renzi unveiling a three-year comprehensive reforms program for his government. According to this program, the most urgent task for Mr. Renzi now is to relax the rules that make hiring and firing difficult in the labor market. Mr. Renzi came to power in February with the promise of a new electoral law and structural reforms such as radical changes to the labor market, public administration, and tax system. Although this reform agenda has not fully taken off, the prime minister has succeeded in reducing the membership and powers of the Italian upper-house Senate, a move which is expected to speed up lawmaking. He has also implemented a tax break that has provided an additional $100 a month to the lowest earners.
SPAIN: RECOVERY SUSTAINS MOMENTUM; UNEMPLOYMENT DECLINES SIGNIFICANTLY
In sharp contrast to the other large economies in the Euro-zone, Spain continued to recover during the third quarter. Preliminary data released by the country’s National Statistics Institute show that between July and September, Spanish GDP expanded 0.5 percent compared to the second quarter and 1.6 percent compared to the same period a year ago. The Bank of Spain (central bank) has said that consumer spending has been driving growth lately as Spanish households, which have been paying off debt for a long time now, have finally started loosening their purse strings.
The trend is noteworthy because Spain has had a consistent recovery since last year largely on the strength of its exports. However, with the current slowdown in many parts of the globe, especially Europe, Spain’s export outlook has weakened and the country is now increasingly relying on domestic spending for growth. According to the Bank of Spain, a decline in the government’s borrowing costs, improved business confidence, and falling unemployment are also helping the economy.
Speaking of the labor market, the number of Spaniards without a job dropped by 195,200 to 5.43 million during the third quarter. In fact, Spain’s unemployment rate — which is the second highest in the Euro-zone after Greece — fell from 25.7 percent a year ago and 24.5 percent in the second quarter to 23.7 percent at the end of September, its lowest level since 2011. According to the National Statistics Institute, a large decline in the number of foreign workers helped to bring down the unemployment rate. Still, this is a significant achievement for Spain because it showcases Spain’s success in reforming its labor market. While countries like France and Italy have been struggling to embrace reforms, the Spanish economy has scripted a remarkable turnaround story in part due to structural changes like the one implemented in 2012, when it was made easier for employers to fire workers or cut wages.
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