I’ve warned all year about not getting too carried away with heightened expectation of growth in the Euro zone and Japan. That caution has been rewarded with underwhelming June quarter growth for both. Sure Japan beat expectations (-1.6% qoq annualised vs -1.9% expected) but only because the economy contracted less than expected. And while the Euro zone posted modest growth in the quarter (+0.3% qoq), it and its three largest constituent parts (Germany, France and Italy) all fell short of expectations.
At this stage we don’t have a breakdown of Euro zone-wide growth but prior releases of retail sales suggests consumption was a likely solid contributor to growth over the quarter and we expect exports would have been OK for some, especially Germany. However indications from the respective national statistical agencies are that business investment was weak in at least France and Germany.
To be fair, annual growth of 1.2% for the year to June is the strongest since September 2011, but it’s hardly shooting the lights out. Easy monetary conditions should continue to support a further cyclical upswing via the low exchange rate, low interest rates while the TLTRO will continue to support stronger credit growth.
The question for the ECB is whether growth becomes strong enough to lift inflation from its current “unusually low” level, let alone maintain it at close to their 2% target. Until they are of that view expect the central bank to continue its program of sovereign bond purchases.
A contraction in Japan Q2 growth was widely expected. Consumption was weak over the quarter, despite better labour market data, and exports were weaker still. Capital expenditure also posted a small negative (although this could yet be revised up and came after a solid Q1). The only positive surprise was inventories which posted a small positive contribution where a negative had been expected following the significant inventory build in the first quarter – but that will simply serve to suppress future production.
Looking ahead we think consumption will look a bit stronger next quarter while there are pluses (US) and minuses (China) for exports. And stronger capex remains a pre-condition for any sustained pick-up in growth. I’ve got a rebound to 2% growth penciled in for Q3. The Bank of Japan lowered their growth and inflation forecasts recently but they are likely still too optimistic on both fronts making further monetary easing likely.