German Retail Sales January and PMI February

A number of new data readings have come out from Germany during the last week, and these are leading me to some slight modification of the short term outlook I was painting in my most recent post, although my feeling is that in the mid term little has essentially changed.

It is clear that some slight easing in the downward process is Germany is now taking place, and the recent data are too consistent to ignore on this front. Perhaps the clearest indication of some sort of steadying as she goes can be found in the latest reading for Germany on the EU Economic Sentiment Indicator, with Germany reporting a slight increase in confidence, up to 103.7 in February from 103.1 in January.





The last IFO business sentiment index reading was also not as weak as might have been expected, the GFK consumer confidence reading remained stationary, unemployment continued to fall on a seasonally adjusted basis,and the January retail sales data and February PMI reading indicate an expansion in German retail sales for the first time in several months. Of course how long this will last, and how important the phenomenon will prove to be, is very hard to say at this point. Looking at the general economic environment I wouldn't be betting on any kind of very strong upswing, but the numbers are interesting, and I wouldn't be surprised at all to see some slight recovery in the export situation in January when we get the data. An Eastern Europe effect perhaps? Certainly several economies are still accelerating there, almost to overheating.

Then there is the retail sales data.

According to provisional results released by the Federal Statistical Office turnover in the German retail trade was up by 2.7% in nominal terms and 0.6% in real terms in January 2008 over January 2007. When adjusted for calendar and seasonal variations the January turnover was in 1.9% higher in nominal terms and 1.6% in real terms over December.



Now this is not an earth shattering change, but it is significant. If we add to these results the latest reading on the Bloomberg retail sales purchasing managers index, which rose to 52.1 in Feb from 44.2 in Jan (according to data released yesterday by NTC economics), then obviously we can see that the sales climate has improved somewhat. In fact this was the first time in almost a year that German retailers anticipated that future sales performance would exceed plans, while the retail sales rose for the first time in five months. The last time the retail PMI registered an expansion was in September 2007.



Clearly it is very hard to decide how to read all of this at this point, but I imagine things will become clearer as the days pass. Certainly the general direction of private domestic consumption does little to encourage us to expect that domestic consumption will be able to do much to sustain the current expansion if exports continue to slow, so the export data in the coming months will be crucial, and should tell us a lot about what is actually happening at the present time. Certainly according to Trichet, as reported in Bloomberg this morning, it is - as I tended to suspect - largely an East European driven exports story, and if this is the case we will all need to watch out if there is any sort of major "correction" in Eastern Europe.

Spanish Economy Slowdown Update

Quite a bit of Spain related data has come out over the last few days, including the latest flash estimate for CPI inflation from the INE, which came in at 4.4% for the second month running.



Given that most of the Spanish economy is slowing rapidly this sort of inflation is likely to prove itself to be a real headache, especially over at the ECB. The problem is only added to by the latest reading on the producer price index which was up 6.6% year on year in January, indicating that there is still a lot of inflation momentum in the system.




The European Commission also reported at the end of last week a further steep decline in its eurozone “economic sentiment” indicator for February, with the composite number reaching its lowest level since December 2005. The indicator, which gauges optimism across all economic sectors and is regarded as a good guide to likely future trends, fell to 100.1 points in February from 101.7 in January.

This seems to imply a significant deceleration in activity, although the picture is very variable. France is holding up better than most, and Germany (as explained here) is hanging on in more than I personally expected, but Italy is very much in the doldrums already, and the two "construction driven" eurozone economies (Spain and Ireland) are in strong downward retreat.




The countrywide fall was led by the service sector but the index for Spain, were the impact of a bursting property bubble is in the forefront of everyone's mind, was especially pronounced. With a reading of 87.5 the indicator hit its lowest level since January 1994. Italy’s index also dropped steeply, to the lowest level since August 2005.

One measure of the slowdown in activity is the rate of expansion in industrial output, which has proved rather volatile, but the rate slowed notably during the year, with the year on year changes being neagtive in both November and December.



We also now have the December mortgages data, and as was to be expected, both the value and the number of new mortgages was down. The average value of the new mortgages created in December was 161,142 euros and this was down by 1.9% on December 2006, although it was 1.4% higher than the equivalent number for November 2007. For housing mortgages alone the average amount was 143,739 euros, 0.2% more than in December 2006, and 2.2% less than in November. Even more significantly the number of new mortgages in December (102,976) was down 26.87% on November and 14.6% on December 2006. As a result of the reduced numbers of properties being newly mortgaged the total value of mortgage loans (16.59 billion euros) was
down 25.88% on November and 16.24% on December 2006.




Finally we have what Wolfgang Munchau calls in his weekend op-ed in the Financial Times his favourite current chart (although why anyone would call such an appaulingly depressing picture a favourite is beyond me) - the one from the Bank of Spain which shows how building approvals and permits have (and I quote him) "fallen off the edge of a cliff since the end of 2006".




As Munchau points out, at their peak in March 2007, house building permits were rising at an annual growth rate of 25 per cent. In the autumn of 2007, their annual change had dropped into the region of minus 20 per cent. The situation in terms of approved starts is even more dramatic, since these rose at an annual growth rate of close to 28 per cent in March 2007. By September the annual rate of change had fallen to minus 66 per cent. House prices have not fallen significantly in Spain yet, but this is surely only a matter of time, and especially when we come think about the large stock of unsold new homes (estimated at 500,000 as of March 2008) waiting on the books, and the drop in the number of mortgage loans mentioned earlier in this post.

Munchau correctly ties the capital inflows which have taken place to finance the previous boom with the huge balance of payments surplus Spain currently runs (Spain needs in the region of 9 billion euros in external finance a month to keep this afloat), but I'm not sure he has yet appreciated what a problem for the Spanish banking and indeed whole eurosystem this financing problem can become, since while he correctly points out that in the Spanish case "there can be no currency crisis....since Spain does not have its own currency", he omits to ask himself the equally pertinet question as to whether or not there could be a banking crisis. As I try to argue in this post there most certainly can.

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.

February EU Commission Interim Forecast

The European Commission released a new interim forecast for the EU economies yesterday. Of particular note was the fact that the forecast significantly reduces the growth forecasts at the same time as sharply raising its inflation estimate The Commission said it was concerned that expectations of steadily rising prices were becoming entrenched in the 15-nation area.

My own opinion is that the current forecasts are far more realistic than than those issued in last November's autumn review. The outlook for growth in the eurozone as a whole for 2008 has been cut to 1.8 per cent from an earlier 2.2 per cent, but of more significance perhaps are the individual country estimates. Italy, which has been the eurozone’s slowest growing economy for the past 15 years, once again comes in at the bottom of the pile, with the Commission halving its growth forecast for this year to a mere 0.7 per cent. This follows a downward revision of the Italy growth forecast by the Bank of Italy (in the middle of January) to 1%, and a revision (earlier this month) by Confindustria, Italy's largest employers' lobby, who slashed their forecast also to 0.7%. Back at the start of January I said this on my Italy blog:

I personally will be very surprised if we still see calendar year 2008 anything like as high as 1.8%, but more to the point even 1.3% may be rather on the high side if we get a significant deterioration in the external environment, especially in Eastern Europe on which Italy is fairly dependent, and where the Italian banking sector has significant exposure. So that puts me much nearer to Pillona's "basement bargain" number of 0.5% than to any of the others. One of the reasons for my pessimism relates to my assessment of Italy's current trend growth rate, and to the level of fiscal and monetary tightening which may be operating on the economy even as it slows. During 2007 the Italian govenment has been running a fiscal deficit of comfortably below the 3% of GDP required by the EU commission. But since this fortunate situation was in part acheieved by the use of one off measures, and in part by the strong tax inflow from the above trend growth, the government will need to maintain a comparatively tight fiscal stance to keep things on course, and any attempt to further loosen may run into real problems with the EU commission and the credit rating agencies. And as I keep arguing, it is very hard to see an accomodative monetary posture from the ECB in the near future. The IMF in their October World Economic Outlook came in with a similar figure of 1.3% for 2008, the Economist Intelligence Unit is forecasting 1.7% in 2007 and 1.4 in 2008, and the latter 2008 figure was also endorsed by the EU commission in its November forecast.


As I indicate, my own view is well to the downside of all this. The only apparent bright spot on the horizon is employment, but I am dubious that in the context of Italy's ageing workforce this will work through as some are hoping, as I expain at some considerable length in this post here. My opinion is that Italy will enter recession at some point during 2008, and that we may well have 2 consecutive quarters of negative growth. The continuing high euro will maintain pressure on Italian exports, and high oil and food prices will maintain pressure on the inflation front, at least in the firts half of 2008. At the same time, and despite rumours that Romano Prodi's government is compemplating a large tax cutting package, I anticipate that the fiscal environment will remain tight. Italy's large (106% GDP) accumulated debt, and the vigilance from the gentlmen at Standard and Poor's and the other credit rating agencies more or less guarantee that.

I wouldn't say it exactly makes me happy to be being proved right here, but we do need some more realistic perspective on Italy's current growth potential from those responsible for forecasts and policy, and some more realistic appraisal (ie of population ageing) to try and understand why things are this way, rather than assuming it is all to do with some sort of congenital weakness on the part of the Italians.

The Commission lowered its country forecasts for Germany (to 1.6 per cent, from 2.1 per cent), and France (to 1.7 per cent, from 2.0 per cent), for the UK (to 1.7 per cent, from 2.2 per cent), and for Spain (to 2.7 per cent, from 3.0 per cent). Of these the French one looks to be the most realistic. The German forecast obviously contains strong downside risk, while the Spanish one seems to be talking about "another country" from the one I live in, when we come to look at the rate of the slowdown in the real economy (retail sales, industrial output, services etc), and add to this the growing tensions in the banking and financial sectors. I would stick my neck out and go for sub 1% growth in Spain this year, and feel reasonably comfortable with this.

Economy and Finance Commissioner Joaquim Almunia stressed the Commission’s view, which has been expressed many times since the financial market turbulence began last August, that the European economy would weather the storm because of its "sound fundamentals" – stable public finances, no huge current account deficits, relatively low unemployment and stronger international competitiveness. The strange thing is that he actually comes from Spain, a country which, it is true, has sound public finances at this point, but does have a huge (or whopping) current account deficit, which since last autumn it is having trouble financing since the monthly inflow of funds has dropped by around half, high (and growing) unemployment (around 10%) and poor producyivity growth (one of the worst in the EU) and hence comparatively weak international competitiveness. For these and many other reasons I suggest the 2.7% number is absolutely "pie in the sky", and may have a lot more to do with the fact that Spain is going to have elections in the middle of next month, with Mr Almunia's own party (PSOE) attempting to secure re-election.

On the inflation side the Commission raised its estimate for 2008 for the 27-nation EU to 2.9 per cent from the earlier 2.4 per cent, a revision which won't make the task of the ECB any easier when it comes to trying to use monetary policy to address the growth slowdown issues.