Ailing economy to get policy booster - Capital Economics
European Economics

Ailing economy to get policy booster

European Economics Weekly
Written by Andrew Kenningham

A mixed bag of data releases this week leaves us happy with our forecasts for a 3% contraction in GDP this quarter and a strong recovery next year as vaccines are rolled out. Next week, the ECB will promise to continue doling out its medicine, and there is a good chance of progress on the stalled EU Recovery Fund.

Brighter times ahead

The week’s data releases have been a mixed bag. The good news is that retail sales rose by 1.5% m/m in October which lifted them to 3.1% above their February level. But things have taken a turn for the worse since then. The services PMIs for November fell in all the major countries. And although the manufacturing PMI for the euro-zone remained above 50, this was only thanks to the strength of the German manufacturing PMI which, at 62.2, confirmed that the sector is still going gangbusters.

All of this is consistent with our view that euro-zone GDP will fall by around 3% in the current quarter and tread water early next year. Beyond Q1, though, activity should rebound quickly as the vaccination programmes allow governments to reduce their virus containment measures. Our forecasts are above the consensus and those of the ECB, although the latter will be updated next week.

Euro strength or dollar weakness?

The appreciation of the euro to nearly $1.22 at the time of writing means it is at its strongest level against the dollar since April 2018. This may attract some attention at the ECB meeting next week. After all, the currency has now risen by nearly 14% against the dollar since its low-point this year, in mid-March. And the account of the September ECB meeting includes multiple references to the impact of the euro’s appreciation on inflation.

However, we continue to think that the euro exchange rate is not a major problem at current levels. For a start, it has appreciated by only 5% over the same period against a broad basket of currencies. So the latest upward move against the dollar has not been reflected in the so-called nominal effective rate. (See Chart 1.) And secondly, the euro is only around its long-run average in real effective terms which suggests that it is not fundamentally over-valued.

Indeed, we think the euro will continue to strengthen in the coming years (see here). Meanwhile, although we expect inflation to remain a long way short of the ECB’s target, we do not think that the exchange rate will be a major factor behind this.

Chart 1: Euro Exchange Rates

Sources: Refinitiv, Capital Economics

Spain makes budget progress

The approval of the Spanish government’s 2021 budget by the lower house of parliament this week marks a big step forward. Indeed, it is the first time since mid-2018 that the government has been able to pass any budget at all, and no full-year spending plans have been approved since 2016.

This is clearly good news, not least because it will unlock money from the EU Recovery Fund. But Spain’s political landscape remains very fractured, with the government depending this time on support from Basque and Catalan secessionist parties which cannot be relied on to provide consistent support and/or may demand more autonomy. Further reform efforts may be held back by the politics, clouding the medium-term economic outlook.

The week ahead

The main event next week will of course be the ECB Governing Council meeting on Thursday. As discussed in our ECB Watch, the emphasis will be on continuing to administer the current dose of monetary medicine for a lot longer than previously expected. Also on the policy front, there is a good chance that the EU multiannual budget framework is agreed at the leaders’ summit on Thursday and Friday, though this would require a climb-down from Hungary and Poland over the law and order provisions. (See here.)


Data Previews

German Industrial Production (Oct.) Mon. 7th Dec.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

Industrial Production m/m (y/y)

07.00

+1.6%(-7.3%)

+1.3%(-4.8%)

+3.0%(-3.5%)

Another increase

We think that industrial output probably increased again in October and that the sector is likely to hold up reasonably well despite the lockdowns.

Industrial production rose by 1.6% m/m in September, although this was a little disappointing given the strong survey data and left it still over 8% below its February pre-coronavirus level.

Another rise in October looks likely. Business surveys suggest that the sector continued to grow rapidly, with the manufacturing output PMI rising to 65.1, close to an all-time high. While the industrial orders data are not always a reliable guide to production, they rose by almost 3% m/m in October. All in all, we are pencilling in a 3% m/m increase in industrial production for October. That would leave output around 5.5% below its level in February, which would still be a bigger shortfall than in the other major euro-zone economies.

The industrial sector is likely to continue to fare well. Admittedly, Germany’s “Lockdown Lite” has been in force since the start of November and will remain in place until mid-January if not much later. But the restrictions are not aimed directly at industry and daily truck toll mileage data point to a further improvement. (See Chart 2.)

Chart 2: German Truck Toll Mileage & Ind.Prod.

Sources: Refinitiv


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time CET

Time (GMT)

Previous*

Median*

CE Forecasts*

Mon 7th

Ger

Industrial Production (Oct)

08.00

(07.00)

+1.6%(-7.3%)

+1.3%(-4.8%)

+3.0%(-3.5%)

Tue 8th

Net

CPI (Nov, EU Harm.)

06.30

(05.30)

+0.8%(+1.2%)

Fra

Trade Balance (Oct, nsa)

08.45

(07.45)

-€5.8bn

EZ

Employment (Q3, Final, q/q(y/y))

11.00

(10.00)

+0.9%(-2.0%)p

+0.9%(-2.0%)

Ger

ZEW Economic Sentiment (Dec)

11.00

(10.00)

39.0

40.5

EZ

GDP (Q3, Final, q/q(y/y))

11.00

(10.00)

+12.6%(-4.4%)p

+12.6%(-4.4%)

+12.6%(-4.4%)

Ger

Trade Balance (Oct, nsa)

08.00

(07.00)

+€20.6bn

Wed 9th

Spa

Industrial Production (Oct)

09.00

(08.00)

+0.8%(-3.1%)

Thu 10th

EZ

EU 10/11 Dec. Summit Begins

Fra

Industrial Production (Oct)

08.45

(07.45)

+1.4%(-6.0%)

+0.4%(-5.5%)

Gre

CPI (Nov, EU Harm.)

11.00

(10.00)

+0.3%(-2.00%)

Ire

CPI (Nov, EU Harm.)

12.00

(11.00)

-0.5%(-1.5%)

EZ

ECB Interest Rate Announcement

13.45

(12.45)

-0.50%

-0.50%

-0.50%

Fri 11th

Spa

CPI (Nov, Final, EU Harm)

09.00

(08.00)

+0.1%(-0.9%)p

+0.1%(-0.9%)

Ger

CPI (Nov, Final, EU Harm)

10.00

(09.00)

-1.0%(-0.7%)p

-1.0%(-0.7%)

Ita

Industrial Production (Oct)

10.00

(09.00)

-5.6%(-2.1%)

+0.6%

Ita

Unemployment Rate (Q3)

11.00

(10.00)

8.3%

Selected future data releases and events

Mon 14th

EZ

Industrial Production (Oct)

11.00

(10.00)

-0.4%(-6.8%)

Tue 15th

Ita

CPI (Nov, Final, EU Harm)

10.00

(09.00)

-0.1%(-0.3%)p

-0.1%(-0.3%)

Wed 16th

EZ

Markit Composite PMI (Flash, Dec)

10.00

(09.00)

45.3

EZ

Markit Services PMI (Flash, Dec)

10.00

(09.00)

41.7

EZ

Markit Manufacturing PMI (Flash, Dec)

10.00

(09.00)

53.8

EZ

Labour Costs (Q3, q/q(y/y))

11.00

(10.00)

+3.9%(+4.2%)

EZ

Trade Balance (Oct, sa)

11.00

(10.00)

+€24.0bn

Fri 18th

Ger

Ifo (Dec)

10.00

(09.00)

90.7

*m/m(y/y) unless otherwise stated. p=provisional. Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts

%q/q(%y/y) unless stated

Latest

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021

2019

2020

2021

2022

GDP

+12.6(-4.4)

-3.0(-7.1)

+0.7(-2.8)

+3.0(+13.4)

+2.7(+3.3)

+0.8(+7.3)

+1.3

-7.5

+5.0

+4.0

Household Spending

-12.4(-16.0)

-3.0(-6.7)

+1.5(-0.8)

+3.5(+17.1)

+2.2(+4.1)

+0.7(+8.1)

+1.3

-7.6

+6.8

+3.6

HICP (%y/y)

-0.3 (Nov)

-0.2

0.2

0.9

1.1

1.2

+1.2

+0.3

+0.8

+0.8

Unemployment Rate (%)

8.4 (Oct)

8.5

9.3

9.1

8.9

8.6

7.6

7.8

9.0

8.0

Depo Rate, end period (%)

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

10yr Bund Yield, end period (%)

-0.56

-0.50

-0.50

-0.50

-0.50

-0.50

-0.19

-0.50

-0.50

-0.50

$/euro, end period

1.21

1.20

1.21

1.23

1.24

1.25

1.12

1.20

1.25

1.30

£/euro, end period

0.90

0.89

0.89

0.89

0.89

0.89

0.85

0.89

0.89

0.90

Sources: Bloomberg, Capital Economics


Andrew Kenningham, Chief Europe Economist, andrew.kenningham@capitaleconomics.com