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Wednesday, February 27, 2008

German GFK Consumer Confidence, The Euro and the Future of Eurozone Growth

German market research group GfK's forward-looking consumer climate index was unchanged at 4.5 points in March 2008 from February. Since the forward index is unchanged at a rather low level this is not especially positive news.




And since the constant reading is the by-product of a number of significant shifts in the sub-components, it is perhaps worth looking at these in detail. Firstly economic expectations:


The slight improvement in economic expectations apparent in January has not been sustained for long. After rising by a good 5 points at the start of the year, the indicator dropped considerably in February and fell 14.1 points to stand at 14.6. A decline of this order of magnitude has not been since the end of 2006.





The evolution in this index does not look at all positive, to say the least. Then we have the propensity to buy.

After two consecutive rises in a row, consumer propensity to buy in Germany dropped back significantly in February and the indicator fell from minus 8.8 points in January to minus 15 points.




This index is now well bogged down in negative territory, which is entirely consistent with the contraction in domestic consumption seen in Q4 2007. Finally income expectations.

After a slight dip in January, income expectations rose again this month, with the indicator climbing 4.2 points to its current level of minus 0.5 points. After two slight falls in a row, consumers’ expectations regarding their own financial situation are therefore once again at the level recorded in November 2007.






As we can see, this has stabilised and even improved very slightly in the last couple of months. Unfortunately, this is likely to be the most carefully watched indicator over at the ECB, and this sudden revival in income expectations is just what they don't want to see. Basically the distribution of the sub components would seem to be the worst of all combinations from the point of view of macro economic policy making, although not - it is worth noting - from the perspective of euro/dollar market participants, and it is not surprising that the combination of yesterday's news about the IFO reading and this GFK one has finally sent the euro through the 1:50 barrier.

The Munich-based Ifo institute said yesterday that its business climate index, based on a survey of 7,000 executives, increased to 104.1 from 103.4 in January. But as we can see in the chart below this rise was only a very moderate improvement, and the change was largely in the current conditions component, without much significant change in the longer term outlook.



The dollar in fact went up as far as $1.5047 per euro, the lowest since the European single currency was introduced in 1999, before trading at $1.5017 as of 6:47 a.m. in London from $1.4974 in late New York yesterday. The euro reached a six-week high against the yen as traders continued to bet the ECB will keep its 4 percent rate unchanged in coming months, with euro falling back to 160.56 yen after reaching 161.39.


Obviously what now gets to happen next would seem to be anyone's guess, since we are well past the point were previous experience could be considered a sure guide. Clearly one possibility is that this euro "rally" will rune out of steam (but would we be right at this point in treating this simply as a rally, may it not be more a structural by-product of something or other, see below). For one thing, for the euro to receive a substantial downward correction one has to assume that the US treasury would simply sit back and let it happen. But the US is itself in the midst of its own hard fought "dollar correction" which is seen as being essential to correct the current account imbalance, so at the present point the US Treasury are far from being unhappy with the current state of Euro-USD, and they could resist anything which smelt of a sharp upward correction in the dollar, maybe even by selling dollars.

I am sure they would accept a moderate downward adjustment, say - guessing for illustration purposes - to 1.40. But I am not sure they are ready willing and able for a major upward hike in the dollar. Nor are very many people in the financial markets anticipating this outcome, even though the macro economic data we are seeing would be much more in harmony with such a view.

Again, neither the Japanese and nor the Chinese would be especially happy about the advent of a "cheaper euro" since they have been tending to regard the European markets as a convenient fall-back position in the face of a weakened export market in the United States (and it might be interesting for someone or other to explore what the Russians and the Gulf-peggars would be looking for at this stage). Basically there are some pretty hefty players at the central bank level out there pushing their own interests, and many of these will not coincide with the forward looking macro concerns at the ECB, so we need to try think about and monitor how they respond at each given stage.

Basically, as I have been arguing, there are two opposite tendencies at work here. A short term one for the dollar to fall vis a vis the euro, and a longer run one whereby both of them have fall against an as yet unspecified basket of currencies. The basket may be unspecified, but my guess is that the rupee and the real will be in it. Possibly the Turkish lira. In fact how all this might pan out is that those who are left in the basket of emerging market currencies tracked by Bloomberg after the coming correction is over (ie, for example, after Eastern Europe has been forcefully stripped out) might well go to form the emerging nucleus here. So market realities rather than G7 policy may well be the final determinant here, which I suppose, given the zeitgeist of the times, would only be appropriate.

What I am trying to work out as all this moves forward is what weighting (in that mental topological map we all carry round in our heads I mean) to give to each of the processes - the short one and the long term on I mean. Up to the end of last year I was always expecting a euro crash against the dollar (since the underlying longer term macro seemed to suggest this), but then so many things have happened that neither I nor anyone else was expecting (I WASN'T expecting so many immigrants to arrive in Spain over the last 5 years, for example, and I wasn't expecting the Japanese housewives loss of home bias, nor the way in which local central banks could lose control of monetary policy etc etc) that I think the only thing to beware of at the moment are the "we've seen all this before" type of arguments".

So now I am not so sure at all what gets to happen next, and I am would be simply arguing for keeping a semi-open mind, and following closely what actually happens as it happens. This is also the case since there is no easy and obvious solution that suits everyone here, and that is always a problematic factor.

Meanwhile, the German economy is visibly slowing. The detailed GDP data were out earlier in the week, and quarter on quarter growth is slowing steadily and inexorably.



The rate of increase in monthly exports is also falling raidly (to zero in December)




while houshold consumption has suffered a complete slump since the heady days of the pre VAT hike in Q4 2006.




And it is not simply the German economy that is slowing, none of the "big four" could be argued to be in perfect shape. Italy may already be in recession. ISTAT haven't even had the stomach to release the Q4 2007 numbers yet, although everyone who will have seen the provisional version of them has been busily revising down the 2008 outlook considerably.

Almost all the macro data we have seen coming out of Spain over the last three months (retail sales, industrial output, services activity, consumer confidence) has been unequivocally bad. Strangely the only vaguely positive reading was Q4 2007 preliminary GDP data, and we are still waiting for details to try and understand why this should be the case. Spain seems to have had a bank loan sudden dead stop in December, and according to the latest Eurostat release construction activity is now falling heavily (down 9.5% year on year in December). So we now seem to face the very preoccupying possibility of a credit crunch and systemic banking crisis feeding into a naturally slowing real economy.

The only vaguely positive outlook among the big four would seem to be in France, where performance is holding up rather better than the rest, but how long this will prove to be sustainable if the rest continue to head south is a very moot point indeed.


Germany continues to constitute the major puzzle for many observers. Job growth continues, but at the same time consumption slides. Evidently with so many older workers being sucked into employment the bang per buck in jobs for consumption terms seems low, and many of the jobs being created may have a very low real economic content. On the other hand, despite some slowdown of late Germany is apparently exporting and investing like hell, but what the question we need to ask ourselves is just how vulnerable that may be to any problems which boil over in Eastern Europe.


Basically German export growth is highly interlocked with growth in the EU10, and to a lesser degree Russia, Ukraine, Serbia, Croatia etc. Some of these economies are still accelerating very rapidly - Poland, Slovakia, the Czech Republic, Romania Ukraine, Russia etc - and obviously Germany is getting a lot of very positive spin off from this. But much of this frenetic growth this isn't going to last very long. The strong uptick in inflation across the whole region suggests that one economy after another is now overheating, and some who have already blown out after the over-heat are now steadily "cooling" - Latvia, Lithuania, Estonia, Hungary, possibly Bulgaria. So how far are we away from all this overheating producing a sudden bout of "cooling" in a wider group of East European economies. Months at the most I would say. And if this view is right, and Germany can no longer continue to boost sales in Eastern Europe to get growth, what does that tell us about the ability of its export dependent economy to stand the pressure of a very high euro-dollar as we move forward? This I think is the key question we should all be asking ourselves at this point.

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