The German coalition deal includes measures to boost domestic wages and consumption. In our view, these measures will help rebalance trade flows within the Eurozone, and will, if passed into law, help Southern Europe to get out of the economic depression via higher exports. In the short term, however, monetary developments show a collapse in money supply growth driven by bank deleveraging ahead of the ECB stress tests next year. We expect the ECB to expand its policy toolkit in 2014 to fight off deflation and accommodate the credit crunch by private banks.
German coalition deal could help Southern European exports
After five weeks of negotiation, Germany’s major parties finally reached a deal last Wednesday: Merkel’s CDU will join forces with the SPD and give birth to a new coalition government (subject to the SPD’s activists approving the deal in a ballot to be held in mid December). The 185-page document (link here to the original document – in German) includes several economic reforms which we believe have the potential to radically change the crisis dynamics in the whole of the Eurozone. Let’s highlight two of these which we believe are especially significant:
- minimum wage of EUR8.5 per hour;
- pension age reduced to 63 years (from 67) for certain classes of workers.
Both of the above reforms would represent a departure from the kind of economic model that has made Germany so economically successful. The German model has been based on export competitiveness, with an extremely flexible labour market resulting in stagnant real wages (see Real wages in Germany – Numerous years of decline) and subdued internal demand.
Setting the minimum wage at such a high level will likely result in an acceleration of domestic demand, which will in turn reflect on the German trade balance, helping Southern European countries incomes improve as well via higher exports. We have discussed intra-European trade imbalances in previous posts (see Trade imbalances take center stage) and believe the announced reforms partly address the problems we highlighted.
Meanwhile, as retail trade for October showed a cautious consumer in Germany (possibly an election side effect), the GfK survey gives a better outlook for December sales:
- the GfK index for December registered a strong increase to 7.4 (from 7.1). In November, economic expectations improved for the third consecutive month to the highest reading in more than two years (to 20.3 from 11.3); income expectations rose to their highest value since March 2001 (to 45.2 from 32.7); willingness to buy reached a seven-year high (to 45.7 from 44.4); this set of data contrasts sharply with French household confidence data, that slightly decreased to 84 in November (from 85);
- in October, retail trade fell by 0.8% m/m (from -0.2% m/m, seas. adj. in real terms);
- the unemployment rate stood at 6.9% in November to 2.985 million unemployed persons (10,000 more than in October).
Italy: positive data on confidence and trade, but Berlusconi’s exit leaves the government weaker
Apparently, you can only have so many working government coalitions in Europe. As German parties agreed on a (counter) reform agenda, the governing coalition split in Italy. Mr Berlusconi’s newly formed party (Forza Italia) withdrew its support to the Letta government, leaving it with a thin 6-votes majority in Senate – hardly enough to govern a country that needs deep institutional reforms.
Nevertheless, some data points published during the week allow for some optimism on the country, at least in the short-term:
- foreign trade with non-EU countries showed a 1,868 million surplus in October (from 1,572 million, seas. adj. in September), as export rose by 0.8% m/m (from 1.2% m/m) and imports fell by 1.3% m/m (from +0.4% m/m). As we have already highlighted in the past few weeks, Italy has a surplus to non-EU countries as well as to EU, non-Eurozone countries but runs a significant trade deficit with “core” Eurozone countries (Trade imbalances take center stage);
- consumer confidence increased to 98.3 in November (from 97.3 in October);
- the business confidence index jumped to 83.2 in November (from 79.9), as the confidence rose in manufacturing, market services, retail trade and fell in construction;
- the unemployment rate stood at the record level of 12.5% in October ; 3,189 million people are currently unemployed.
The employment picture is not improving yet, but all other indicators are moving in the right direction.
In focus next week: all eyes on the ECB again
On Thursday, the ECB Governing Council will hold the last policy meeting for 2013. Ahead of the meeting, let’s review the latest data on the Eurozone to try to assess what the ECB could announce.
CPI – flash estimates increased slightly to 0.9% y/y in November from the low 0.7% y/y in October that triggered a surprise rate cut last month. However, the inflation rate remains well below the 2% medium term target and parts of the periphery remain mired in deflation. In fact:
- German CPI increased by 0.2% m/m and accelerated to 1.3% y/y (from 1.2% y/y);
- Italy CPI decreased by 0.4% m/m in November (from -0.2% m/m).
What’s even more worrying, is that monetary developments continue to drastically undershoot expectations. In November:
- M3 growth stood at 1.4% y/y, collapsing from 2% in October and undershooting expectations (1.8%). The ECB long-term target for M3 growth is 4.5%;
- private loans contracted 2.1% y/y, faster than in October (2%) despite analysts expecting a milder contraction (1.9%).
On the positive side:
- the Economic Sentiment Indicator (ESI) in November increased to 98.5 (from 97.7), preserving the upward trend started in May (even if it decelerated in the last two months) and the Business Climate Indicator (BCI) rose to 0.18 (from -0.08), marking the seventh successive monthly growth;
- the unemployment rate slowed to 12.1% in October (from 12.2%) to 19,298 million unemployed persons.
In our view, despite the small rebound in confidence and employment, the above data alone would justify additional accomodative actions from the ECB. It is clear to us that the European banking system is furiously deleveraging ahead of the ECB stress tests and is (involuntarily) tightening monetary conditions in the single currency area – something the ECB needs to fight. However, having cut rates last month and having reached the zero bound, the ECB now needs to make greater use of unconventional monetary policy tools (LTRO, QE, negative rates). All of them come with negative, but manageable side-effects. Most important, all of them are disliked by the hawkish (minority – we think) members of the ECB board. Our view is that all of them will have to be deployed in 2014 to accommodate the stress-test induced credit crunch. While we don’t expect any announcement in the December meeting, we think that Draghi will drop hints at that in the press conference next Thursday.
Weekly calendar of economic releases: 2 December – 6 December 2013
(all times refer to Central European Time – CET)
Monday 2nd Dec.
10:00 a.m. – Eurozone, Manufacturing PMI (November)
11:00 a.m. – Eurozone, Building Permits (August)
05:00 p.m. – Global Manufacturing PMI (November)
Tuesday 3rd Dec.
11:00 a.m. – Eurozone, Producer Prices (October)
12:00 p.m. – OECD, Consumer Price Index (October)
Wednesday 4th Dec.
09:00 a.m. – Spain, Import and Export Prices (October)
10:00 a.m. – Eurozone, Composite and Services PMI (November)
11:00 a.m. – Eurozone, Retail Trade (October)
11:00 a.m. – Eurozone, Gross Domestic Product – 2nd estimate (Q3 / 2013)
05:00 p.m. – Global Composite and Services PMI (November)
Thursday 5th Dec.
09:00 a.m. – Spain, Industrial Production (October)
11:00 a.m. – Eurozone, Import Prices (October)
ECB Governing Council Meeting in Frankfurt (Press conference at 02:30 p.m.)
Friday 6th Dec.
11:00 a.m. – Eurozone, Quarterly Balance of Payments – 1st estimate (Q3 / 2013)
12:00 a.m. – Germany, Industrial Orders (October)
By Valeria Palumbo, Marco Troiano