Predicting 2007: How well did we do?

Almost a year ago, in the first days of the then young year 2007, we posted two contributions on Eurozone Watch making five predictions each on the economics and politics of the Eurozone for this. Before we will present our predictions for 2008 in the first days of the next years, it is time to look back and see how we did in 2007.

As at the time of making our predictions, a number of blogs called them to be implausible in the combination, overly optimistic or just noted our out-of-consensus-calls (see here or here ), we would like to make some evaluation of our economic predictions (we borrow this idea from Nouriel Roubini). What sticks out is that we did surprisingly well – so well that we were ourselves surprised and that we have to credit a significant part of the success to pure luck. But let’s have a look at the details – first at our economic predictions and in a later post over the coming days at our political predictions:

1. We predicted that the upswing in the Eurozone would continue, “albeit at a slower pace” and predicted Eurozone growth at “slightly above two percent, after slightly below three percent in 2006″. When we made this forecast, we were clearly above consensus with this view as most economists did not trust the stability of the European upswing. In fact with everything now pointing at a annual growth rate of about 2.6 percent, our forecast was much better than most for the Euro area.

2. We predicted that the ECB would increase interest rates “to 3.75 percent in the first half of the year by a further 25 basis points later on”. At that time, most economists still did not believe the ECB would see any need to hike that far, with the average forecast for the ECB rate for the end of 2008 standing at 3.75 percent according to the FT Deutschland. In fact, we got it almost right to the point: The ECB hiked up to 4.0 percent, and the last hike came in June, so at the end of the first half of the year, but nevertheless, this call was quite accurate.

3. We predicted that the “euro will most likely further gain in value. There is a significant risk that it rises above 1.40 $ in 2007″. This was against the consensus call that the euro would stabilize around 1.30 $. Well, in fact the euro strongly gained in value and went from 1.30 $ to a new record high of 1.48 $. Even if we did not predict the new record high exactly, we are strongly inclined to count this as a hit as well.

4. We predicted that economic divergences in EMU were set to grow but not to be noticed overly much. This turned out to be true: Unit labour costs in Germany, which has already gained a lot of competitiveness over the past years, again increased much more slowly than in the rest of the euro area (0.8 percent compared to 2.0 percent in Spain, 1.3 percent in Italy or 2.1 percent in France). Germany again recorded the strongest export growth of all EMU countries which the problem country Italy recording the slowest export growth. However, due to the good cyclical development, all this was not a big issue in the Euro area in the past year. We also predicted that growth in Finland and Ireland would moderate – as it in fact did.

5. We predicted that both Italy and Portugal, the two problem cases of EMU, would not do much better in 2007. According to the latest figures from the EU, Italy should have recorded a GDP growth rate of 1.9 percent in 2007, the same rate as in 2006. Portugal has grown by 1.8 percent after 1.3 percent in 2006. While Portugal’s growth has accelerated marginally, both countries still are the laggards of EMU with their relative per-capita-income falling. We would at least count this as a half point.

So, in total, we got about 4.5 of our 5 economic predictions correct for this year. Given that we do not have much support staff (in contrast to professional financial sector economists), we think we did quite well. The only downside is that we now have laid the bar quite high for the next year. Nevertheless, we will post our forecasts for 2008 in the first days of January.

Read next: How we performed with our political forecasts.

P.S.: Merry Christmas to our readers!

The Euro-area and the subprime mess: taking the temperature

The past week or so has brought a mixed bag of indicators for the euro-zone with both sceptics and optimists finding bits of their likings. Among the most important positive (and surprising) developments were:

• Business climate actually recovered somewhat in November. Both the German ifo index as well as the French INSEE index recorded increases in November. Manufacturing PMIs for the Eurozone also recorded some slight gains, moving for the whole of the area further away from the 50-points-mark a fall below which would mean an outright contraction of the sector. Companies were even reporting renewed growth momentum in export orders.
• Unemployment in Germany continued to fall strongly and employment creation continued at a strong pace in November, even though many firms by now should feel the pain from the strong euro.
• Finally, according to the details of German GDP figures for Q3, consumption picked up and contributed significantly to growth in that quarter. This is even more surprising as the statistics office had not indicated a significant consumption growth in its description of the GDP flash estimate two weeks earlier.

While some optimists are now claiming that this data shows that things might not turn out that bad for Europe after all, and that the data confirms the story that consumption in Germany will finally turn the corner and provide a sizeable growth impetus for all of EMU in 2008, I would rather interpret this data with caution.

Sure, things could have been worse. Nevertheless, in my opinion the euro-economy is coming dangerously close to stall speed at which any further small shock could lead to a new period of stagnation or even a technical recession (being defined as two consequative quarters of negative GDP growth) in some of the larger EMU member states such as Germany, Italy or France.

The first caveat is that exchange rate changes often take a while until they are seen completely in export order data, even though a first effect is usually seen in survey data very quickly. Thus, given the strong appreciation of the euro both against the dollar and (albeit less) in trade-weighted terms, there might be more unpleasant surprises to come in the coming months.

The second caveat is that the pick-up in German consumption (and thus the rather robust EMU consumption growth) still looks extremely shaky. To come to that conclusion, one does not even refer to retail sales data which show a 2.7 percent drop month-on-month in October (surely a shocking figure, but basically worthless given the quality of retail sales data in Germany and its proneness to large revisions already two weeks after initial publication).

More worringly is the underlying fundamental for consumption: Going into 2008, the development of disposable real income does not bode well for a sustained recovery in German consumption. With inflation having risen to almost 3 percent, any expected gain in real wages well be inflated away by higher oil and food prices. True, employment growth is still strong, but even at a rate of a little more of one percent, it does not add much to the wage sum if real wages are stagnating or even continue to fall.

In addition, one has to see the German consumption growth of 0.5 percent quarter-on-quarter in the summer in perspective. Consumption by now is only about 57 percent of GDP. Even if consumption would be growing by 0.5 percent quarter-on-quarter for the coming year, this would only amount to a GDP growth of about 1.1 percent. If exports and investment slumps (as might happen – see this post here), this might not be enough to keep companies to continue hiring. And given that there is no real wage growth, the consumption growth is very unlikely to be sustained if job creation falters.

However, the increasing risks for the German upswing are not enough. While manufacturing in Germany and France seems to have recovered somewhat, the news for Italy and Spain is not encouraging: In Italy, the manufacturing PMI stagnated at 51.3 points, in Spain it rose slightly above the stagnation-mark of 50 points and reached 50.7 points, leaving the indicators for both countries dangerously close to a the stagnation-territory. Judging by experience, these Southern countries are usually much more vulnerable to an euro-appreciation than Germany. So prepare for more bad news there – and a possible new debate on economic divergences in the euro-zone.