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.
