Wednesday, August 17, 2011

Europe GDP...and more politics

Euro area GDP printed at +0.2% for the June quarter, slightly below average market expectations of +0.3%. The surprise was in the country detail with Germany growing only +0.1% over the quarter, down from a revised +1.3% in March. Forecasts were for a +0.5% expansion in the quarter. France had previously reported a weaker than expect result of “no change” over the quarter.

We had previously expected the weak point in the Europe slowdown to be in the third quarter of the year: Europe appears to be running 2-3 months behind the trend in the US. We now expect to see a similar result for Q3 GDP i.e. a small positive result, before a modest rebound towards the end of the year.

This result highlights again the importance of striking the right between fiscal austerity and supporting economic growth. Ultimately countries with high structural budget deficits and unsustainable debt levels need to grow their way out of the problem.

It also highlights the risk we talked about earlier as the ECB embarked on what we believed was a premature monetary policy tightening. Expect the ECB to revise down their growth forecasts and for the hawkish monetary policy rhetoric to cease. we don't expect them to ease again, at this point, but neither do they need to tighten further.

On the political front, the French and German leaders have concluded a meeting at which they discussed policy options for long-term stability of the Euro area. The most important outcome was their post-meeting unanimity, most likely sensing that last week’s “crisis of confidence” was more about politics than anything else.

They have again talked of obligating all Euro area countries to make balanced budgets a constitutional requirement. We’ve been here before, and we think it’s a necessary step, but we need to start seeing some detail. In particular – what happens when a country breaks the rules? The idea of a financial transactions tax has also re-emerged. More on that another day.

They appeared to pour cold water on the concept of Euro bonds, but all they really did was signal there needs to be considerable alignment of fiscal policy before that can happen. That makes sense to us.