Friday, August 15, 2014

Growth in the Euro zone and Japan

The two economies that have caused me most consternation so far this year have been the Euro zone (more precisely France and Italy) and Japan.  Both reported June quarter GDP this week and neither failed to deliver on low expectations.  But don’t expect a rush to action from either the European Central Bank or the Bank of Japan.

Japan activity data has been volatile recently around the increase in consumption tax that was implemented on April 1st.  The March quarter benefitted from strong pre-tax hike spending which saw GDP expand at an annualized rate of +6.1% only for the economy to give back more than that gain in the second quarter with a contraction of -6.8%.  While that result was a tad better than the consensus forecast, those forecasts had been lowered sharply following the release of weaker-than expected June partial data a couple of weeks ago.

The detail of the result was weaker than expected with a larger than forecast decline in consumption of -5.0% (not annualized!!) and a +1.0 percentage point contribution from private inventory accumulation.  The weak consumption number supports our assertion that consumer spending in Q2 would not only suffer from the payback from Q1 but also from the reduction in real incomes.  Exports were also disappointing but a large drop in imports led to a better than expected positive contribution from net exports.

Looking ahead the consumption result was so weak there must be a bounce back the other way in Q3.  That said, inventories will probably be a drag on growth the next quarter.  I’ve bumped up my Q3 forecast to an annualized 3.5% followed by a return to around trend in Q4.  That results in annual average growth of 1.1% for the calendar year.

Euro zone GDP was unchanged in the June quarter.  Germany was weaker than we were forecasting (-0.2% q/q) while Portugal (+0.6% q/q) the Netherlands (+0.5%) and France (no change) were better than expected.

I’m less worried about the result from Germany.  The Q2 result appears to be a bit of payback from the strong good-weather-related Q1 result.  But I continue to be concerned about the outlook for both France and Italy (the serial non-reformers).  Both will remain a drag on overall Euro zone growth.

I don’t expect the Euro zone to slip back into recession.  Highly stimulatory monetary conditions, lower fiscal drag and a gradual recovery in global growth should see recession avoided.   But I also don’t expect anything near robust growth in the second half of the year.  Our forecast of only modest growth in the second half of the year is expected to result in annual average growth of 0.8% for calendar 2014.

Neither the Bank of Japan nor the European Central Bank are likely to respond to the latest news with new stimulus any time soon.  But there is still a chance they will do more later in the year.  For Japan the key to further monetary policy action is how growth plays out in the in the second half of the year – so it’s still too early.

The ECB undertook new stimulus measures in June including the new TLTRO program.  We expect they will want to wait to see what impact that has before deciding on the need for any new measures.  Also the Euro is now lower which will contribute to higher inflation. We expect this will accelerate once the Fed starts to raise interest rates and we see a stronger USD – but that’s a story for next year.