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Friday, June 01, 2007

Eurozone Growth

Earlier in the week Claus Vistesen asked whether the eurozone might not actually be losing steam. There is certainly evidence to support this view, but having been bitten once - I certainly think I anticipated a rather stronger slowdown in the Eurozone than we saw in the first quarter - it is now a case of "twice shy" with me, and caution is the watchword.

Clearly I do feel that many have been far too quick off the mark in giving the all-clear on the German VAT rise, since this is a permanent structural change, and we may expect the drag on consumption to last over a lot longer period than the first three months of 2007.

That having been said, momentum has continued to be strong in the Eurozone, and German exports (which to some extent drive the process) have continued to power ahead, with - so far - only one or two "blips", possibly associated with the low growth in the US economy in the first quarter.

But growth in Eastern Europe - for example - which is a key destination for German exports continues to be strong, as it does in many other countries across the globe. So since growth in world trade looks set to continue to be strong throughout 2007, this should remain a very positive stimulus for the German economy. It is internal demand which is the issue.

Well, on the retail sales front, the situation seems to have perked up in April:

Retail sales in Germany, Europe's largest economy, in April marked the highest increase since December, a sign that consumption is recovering from a value-added tax increase in January. Sales, adjusted for inflation and seasonal swings, rose 2.6 percent from March, when they fell 0.3 percent, the Federal Statistics Office in Wiesbaden said today.

Well that this is the largest increase since December should not perhaps surprise us, since sales have been pretty stagnant since the VAT rise. Also the current data is contradictory, since readings from the May purchasing managers index suggests contraction in May:

The Bloomberg purchasing managers index for May fell to a seasonally adjusted 47.3 from 55.6 in April, a survey of 500 purchasing managers showed on May 30. A reading below 50 indicates contraction.

On the other hand, in an economy dominated by the services sector, retail sales may not be the most important indicator of what is actually happening.

True German consumer confidence rose to a five-month high in June, possibly fueled by rising economic outlook and income expectations. In particular this won't have done any harm:

Germany's IG Metall, the country's largest union, on May 4 won a 4.1 percent raise for the 12 months starting June for 800,000 workers in the metals industry.

But this does raise the issue of Germany industry's ability to absorb such an increase, coming, as it does, straight on the back of the VAT hike. Some further indication that these cost increases do have an impact comes from the recent stall in the German unemployment decline:

German seasonally-adjusted unemployment total rose unexpectedly in May, according to the federal statistical office. But rise of 3,000 to 3.855m was slight in comparison with the steep falls reported in previous months, and was almost certainly due to the exceptionally warm April and wet May weather.

Meanwhile the latest Royal Bank of Scotland index of manufacturing shows that the rate of expansion in the eurozone slowed in May:

Royal Bank of Scotland Group Plc's index of manufacturing in the 13 euro nations unexpectedly fell to 55 from 55.4 in April... European growth may cool from the fastest pace in six years as rising interest rates and a U.S. slowdown curb demand for the continent's cars, machinery and appliances.....``The momentum in manufacturing is beginning to ebb,'' Ken Wattret, chief European economist at BNP Paribas in London said. ``If this continues, which we would expect, that does raise some question marks about how far the ECB will go. We're pretty skeptical that they'll go beyond 4.25 percent.''...

There are other signs that the euro-region expansion may be cooling. Export growth slowed to 0.3 percent in the first quarter after 3.5 percent in the last quarter of 2006. Retail sales in the euro area fell for the first month in three in May and French business confidence declined.

In manufacturing, new orders gained at the slowest pace since November 2005, with the index reading 55.4 after 55.8 in April, today's report said. Output growth slipped to 56.1 from 56.9, the least since February 2006. Employment growth maintained the fastest pace of growth in 6 1/2 years, with the index reading 53.3, the report said.

Also evidence from Italy seems to back all of this caution up:

Italian retail sales fell for a third month in May as consumer spending continued to be hampered by rising gasoline prices and tax increases.The pace of the decline slowed in the month with a seasonally adjusted index of retail sales rising to 47.7 from 47.5 in April, according to a survey of 440 retail executives compiled for Bloomberg LP by NTC Economics Ltd. A reading below 50 signals a decrease.

Italian business confidence fell in May from a six-month high on concern that gains in the euro and slowing economic growth in the U.S. will hurt exports. The Isae Institute's confidence index fell to 96.2 from a downwardly revised 97.9 in April, the state-funded research center said today in Rome.

Bottom line: all this now needs careful watching. There are a lot of question marks out there, and especially if the ECB persists with the rate hike process.

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