Q3 GDP data confirmed a slowdown in the pace of recovery, and while Ireland and Spain’s announced exits from their bailout programs allow for some cautious optimism, the large trade imbalances remain a key issue for the sustainability of the monetary union. We believe the age of Austerity is over, so a convergence in trade competitiveness now rests on getting Germans to adjust their living standard upwards.
Spain and Ireland to exit bailouts, little progress on single bank resolution, German macro imbalances in the spotlight
The ECOFIN meeting on Friday praised the decision from Ireland and Spain to fully exit the bailout programs (in December and January, respectively). While both countries have undoubtedly taken important steps towards solving their banking and public finance problems, we still believe the main factor allowing for their exit is the improvement in market conditions since by the ECB took a “whatever it takes” dovish stance in 2012. As such, we believe there is still some risk of relapse should market volatility return.
With regards to the Single Resolution Mechanism for failed banks (SRM – a key pillar of the banking union) the meeting of European finance ministers confirmed that the ESM could be used to directly recapitalise banks only after the SSM is established (end 2014). Meanwhile, should the upcoming ECB’s AQR and stress tests reveal capital shortfalls, these would have to be filled via creditor bail-ins and through national sources, with EU level resources only to be employed as a last resort. This is consistent with previous indications, but we would not exclude some changes on this front in the coming months. If the AQR/BSA/Stress tests are to be credible, some banks need to be found short of capital. Forcing national governments to recapitalise weak banking systems out of their fiscal purse may derail the normalization of public finances in some problem countries. Moreover, going into the process without adequate backstops risks exposing the Eurozone to a new bout of speculation. The ECB is aware of this, and despite some resistance from certain core countries we expect a public, EU level backstop to be deployed early.
During the week, signs emerged that Germany will be increasingly pressured to raise domestic consumption in the coming months. After US treasury’s criticism of Germany’s export driven growth model (see this), a blog post by EU commissioner Olli Rehn, discussing German’s external trade surplus, attracted significant media attention. In the post, Mr. Rehn emphasizes the need for Germany to boost its domestic economy by allowing wages to grow, which would in turn reduce its trade surplus and alleviate the trade tensions within the Eurozone. Quoting from Rehn’s blog:
“The EU Council’s recommendations to Germany, adopted in July, urge the country to open up the bottlenecks to the growth of domestic demand. In particular, Germany should create the conditions for sustained wage growth, for instance by reducing high taxes and social security contributions, especially for low-wage earners. The country should further stimulate competition in services – construction in particular, but also in certain crafts, as well as professional services – in order to boost domestic sources of growth.”
We have always believed that the Eurozone crisis was primarily due to the development of current account imbalances, and that the Sovereign and banking crises of the past years are only symptoms of a bigger problem. The focus on trade (and current account) imbalances is an important step forward towards the correct diagnosis of what ails the European economy, and will help shape the correct policy responses to the real economic problems of the continent, which are rooted in different relative trade competitiveness.
Macro wrap-up: GDP data confirms recovery is still very fragile, Italian trade data highlights the competitiveness gap with Germany
The Italian trade balance data for September, published last Friday, offer a good angle to the whole intra-Europe imbalances debate, in our view. The seasonally adjusted trade balance was positive with exports surpassing imports by EUR2.1 bn. Similarly, the trade balance for the whole of Q3 was a positive EUR6.8bn. These numbers are at odds with the prevailing narrative that Italy is uncompetitive, bureaucratic, has a rigid labour market etc. All of the above may be true, but the country is still exporting more than it imports. Looking at the details of the data release (which can be found here) we notice the following (data is not s.a.):
- Overall trade balance between January and September 2013 was a positive EUR 19.6 bn
- Italian trade balance was positive with non EU countries (EUR11.3bn) as well as with EU countries (EUR8.3 bn).
- However, within the EU, Italy’s trade balance towards Eurozone and non Eurozone countries varies a lot. Italy has a positive balance with non-EMU countries of more than EUR 10bn, including a large surplus with the UK, and small surpluses even with countries like Poland or Romania, while the balance with the rest of the Eurozone is negative to the tune of EUR2.6 bn. In particular, Italy has a trade deficit to Germany and Netherlands.
What do we make of all this? Our interpretation is that the Italian (and European) problem is not one of absolute competitiveness. The problem is relative competitiveness between economies which share the same currency. Some northern countries are indeed more competitive than others, but forcing less competitive countries to adjust upwards is just one of the several possible solutions to achieve a sustainable monetary union. Getting stronger countries to allow wage increases (therefore reducing their competitiveness, adjusting downwards) is another one, as are fiscal and monetary transfers from the surplus countries to the weaker ones. The age of austerity is over, and we believe that the German élite will be confronted with the choice to either embrace one of the above two routes or splitting the Eurozone up. Seen under this perspective, allowing wage increases may be the most palatable political option.
Stepping aside from trade considerations, the slowdown in industrial output in September was confirmed by new data points during the week:
- Following disappointing German and French industrial production data last week, a further disappointment came from Eurozone-wide industrial production (-0,5% m/m in September from +1,0% m/m in August – weaker than forecasts);
- In Italy, industrial production was up 0.2% m/m (from -0.2% m/m), in line with forecasts.
Preliminary Q3 GDP data (seasonally adjusted) released during the week painted a mixed picture, but mostly support the view of a very fragile recovery in the Eurozone:
- Eurozone GDP grew 0.1% q/q. This was less than economists had expected and a slowdown compared to Q2 (+0.3%)
- At the country level, GDP expanded by 0.3% q/q in Germany, but unexpectedly contracted 0.1% in France. Italian GDP was still decreasing (-0.1% q/q), but less than expected, fuelling hopes that Italy may come back to growth in Q4. After 9 consecutive quarters of output decline, an Italian exit from recession would be a very welcome development and would follow Spain’s exit from recession this quarter (Spanish GDP expanded 0.1% in Q3).
The latest available OECD composite leading indicators (September) continue to point to modest expansion both for the Eurozone as a whole (to 100.7 from 100.6 in August) and for the major countries, but as we have already seen monetary and inflation developments in October give plenty of reasons to be cautious.
The big question remains whether the Eurozone’s green shoots of recovery will evolve into a sustained expansion or whether Europe is destined to fall back into recession soon. Another recession would deal a heavy blow to hopes of a recovery in banks’ profitability and, combined with the ECB’s stress tests, may lead to further capital raising needs.
In focus: November survey data, confidence
This week, we will get further indications of developments in November, including the German ZEW survey and Ifo business climate index (to be published on Tuesday and Friday respectively). On Thursday, keep an eye on flash estimates for consumer confidence in the Eurozone and PMIs in November (France, Germany, EZ).
Weekly calendar of economic releases: 18 November – 22 November 2013
(all times refer to Central European Time – CET)
Monday 18th Nov.
10:00 a.m. – Eurozone, Balance of Payments (September)
10:00 a.m. – Italy, Production in Construction (September)
11:00 a.m. – Eurozone, International Trade Balance (September)
12:00 p.m. – OECD, Gross Domestic Product (Q3 / 2013)
Tuesday 19th Nov.
08:00 a.m. – Eurozone, New Passenger Car Registration – ACEA (October)
08:00 a.m. – Germany, Employment Rate (Q3 / 2013)
10:00 a.m. – Italy, Industrial Turnover and Orders (September)
11:00 a.m. – Eurozone, Production in Construction (September)
11:00 a.m. – Germany, Zew Survey (November)
OECD Economic Outlook (Vol. 2, 2013)
Wednesday 20th Nov.
08:00 a.m. – Germany, Producer Price Index (October)
Thursday 21st Nov.
10:00 a.m. – Eurozone, Composite, Manufacturing and Services PMI – flash estimate (November)
10:00 a.m. – Italy, Contractual Wages and Salaries (October)
04:00 p.m. – Eurozone, Consumer Confidence – flash estimate (November)
ECB Governing Council meeting in Frankfurt (09:00 a.m.)
Friday 22nd Nov.
08:00 a.m. – Germany, Gross Domestic Product (Q3 / 2013)
10:00 a.m. – Germany, Ifo Business Climate Index (November)
10:00 a.m. – Italy, Retail Sales (September)
Eurogroup meeting in Brussels (03:00 p.m.)
By Valeria Palumbo, Marco Troiano