A more consistent picture with a few exceptions

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shares figures with trend graph

Adverse weather in many advanced economies earlier this year and the 'China slowdown', have made it difficult to read the tea leaves of the global economy. Gradually, a more consistent picture is emerging. I generally like what I see.

France and Italy are struggling to find growth and are still facing big challenges in the area of structural reform. Han de Jong Han de Jong Chief Economist

US weakness a couple of months ago is proving to be temporary; the UK is continuing full speed ahead; the eurozone is doing OK as the peripheral economies are recovering; and fears over a Chinese hard landing during the next couple of quarters are fading. Last week's disappointment came from Germany's Ifo index of business confidence, but I am not going to let its decline ruin my optimistic mood. Meanwhile, there was a Eurosceptic surge in the European elections. We do not see

Eurozone gradually on the up

Let me start with the Ifo index, to get the bad news out of the way. German business confidence fell a little in May as the Ifo index posted a level of 110.4, versus 111.2 in April. May's reading was actually the lowest for the year. The drop in the expectations component was the third monthly fall in the last four months. Thus, business confidence appears to have peaked and is now moderating. The question is what happens next. A further decline of business confidence in the months ahead must not be ruled out - in fact, it is quite likely. But there are a couple of points to note here.

Germany lfo

First, we may be seeing some payback for a strong first quarter, when mild weather supported activity on a seasonally-adjusted basis. Second, we may also start to see some effects of the slowdown in China. As a world-leading exporter of capital goods and cars, the link between the German business cycle and what is going on in China is stronger than for most other countries in the eurozone. Third, the absolute level of the Ifo and its components may be falling, but it is high from an historical perspective.

I must admit that I am not quite sure what that means. Growth of the German economy is by no means bad, but in the past, GDP growth was higher than the current rate when the Ifo index was at current levels. Perhaps the information contained in the Ifo index is more relevant for the direction of the business cycle than for the absolute level of growth. Or perhaps the historically high level of confidence reflects that domestic demand is now making a more important contribution than it often did in the past. Details of the Q1 GDP data show that domestic demand advanced at a pace of 1.9% qoq (not annualised!).  That was the second highest quarterly growth rate since German reunification. Capital investment was up an impressive 3.2% qoq. That is really important as a meaningful strengthening of corporate investment spending is necessary for the recovery to develop along a mature course with significant employment growth. Of course, I must concede that the mild weather will have played a role, so I must not get overly excited.

The preliminary Markit PMIs for the eurozone were also published last week. They paint a picture consistent with the Ifo index: confidence in manufacturing weakened a little. However, the confidence index for the services sector strengthened and the composite index dropped only a tiny bit: from 54.0 to 53.9.

Many people worry in particular about France and Italy, and it is not hard to see why. These countries are struggling to find growth and are still facing big challenges in the area of structural reform and, certainly in the case of France, more and immediate fiscal consolidation is necessary. French business confidence continues to be weak and appears to be weakening further at the margin. Having said that, the leadership in France, and in particular in Italy, is aware of the need for reform and to move in the right direction. In addition, we don't think these countries are facing a big crisis, nor are they likely to cause a new euro crisis. For them the choice is to remain laggards for a long time or to implement reform and join the rest of the eurozone. And a number of indicators for these economies suggest that perhaps they are not in as bad a shape as is sometimes claimed. The Italian economy, for example, is showing some signs of life. As we can see in the chart, industrial sales in Italy are on an upward trajectory.

Italy industrial sales

Another piece of encouraging news came from the European Commission's consumer-confidence gauge. The most recent report, covering May, showed confidence continuing to grind higher. It now stands at its highest level since the start of the crisis in 2008.

The UK economy is continuing its trend of beating expectations - certainly my own expectations. The housing market continues to strengthen, and not only in London. UK retail sales were strong in April. Excluding autos, sales rose by 1.8% mom, pushing the yoy rate up to 8.9%.

Some better news from Asia

Asian economic indicators were also a little better last week. The May HSBC PMI for China registered a sizeable increase. This is not our favourite measure of Chinese business confidence, but we welcome the rise from 48.1 to 49.7 nonetheless. This was the second consecutive rise, suggesting that the downward trend of confidence that emerged in previous months has ended. The Chinese government has also taken some additional measures to bolster economic activity. Both facts support us in our view that a further significant slide in the growth rate of the Chinese economy is not imminent.

Japanese data has been distorted so far this year by two facts. First, heavy snow in parts of the country impacted negatively on activity. Second, the rise in the sales tax in April had a positive effect on Q1 activity as consumers brought forward consumption in order to avoid the higher tax. In 1997, a similar tax increase helped to push the economy back into recession after the hike took effect. As a result, all Japan watchers are anxious to see how far economic indicators fall back in the period after the tax increase. It is early days yet, but last week's signs were not too bad. Department store sales, for example, fell back 12.0% mom in April. That sounds a lot, but they had risen 25.4% in March. Business confidence was also hit by the tax increase, but the preliminary Markit PMI for May shows a modest improvement: 49.9, versus 49.4 in April.

I like to watch indicators in Korea and Taiwan (and some other Asian economies as well) for signs of the direction of the global economy as these economies are early cyclical. It was thus very positive to see that Taiwanese export orders were up 8.9% yoy in April, the best reading since mid-2011.

Taiwan export orders

Little US data

Last week was light on US data. What was released was consistent with our view of gradually strengthening growth, I think. The preliminary Markit PMI, business confidence measure for May, for example, bounced back up after two consecutive monthly declines: 56.2, after 55.4. Home sales were unspectacular, but better than in the previous month. When bond yields rose in the course of last year, the housing market weakened immediately in response. As the housing market, including construction, was a key driver of the recovery, the weakness was unwelcome. It is therefore no surprise that the FOMC is watching the housing market closely, and any active tightening of monetary policy is unlikely if the recovery in housing looks to be unravelling.

Anti-euro surge in European elections

The elections for the European parliament were notable because they saw a surge in support for Eurosceptic parties in a number of member states, most notably in France, the UK and Greece, where these parties actually came top. Perhaps as the current President of the EU Jose Barroso says, such swings should not be a great surprise given the ‘economic, financial and social crisis’ in the eurozone over the last few years. However, the impact should not be overstated. Although the results could put pressure on national governments, in most member states national elections are some way off. There is a possibility that the Syriza party in Greece could force a national election next year, so developments in that country – especially given its unresolved debt problem – should be closely watched. However, the outcomes of national polls, when they come, could be very different. European elections are sometimes used as a protest vote. In addition, the eurozone economy is on the path of recovery and hopefully over time, this should make some inroads in to unemployment. So the economic background when national polls come around could be quite different. Overall, we do not think that these results significantly increase the risks of a re-escalation of Europe’s debt crisis.

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