EUROPEAN OUTLOOK
Data have finally turned upward in Europe, holding out the possibility that the continent could return to slightly positive economic growth for the rest of this year, as the European Central Bank (ECB) has been predicting for some time. Potentially ending an 18-month recession, eurozone GDP expanded by a better-than-expected 0.3% in the second quarter over the first. Growth in Germany was strong, as it was (more surprisingly) in France. The Italian and Spanish economies, while still stuck in recession, produced GDP figures for the second quarter that were somewhat better than anticipated. Spain has also seen a surge in exports, which has been helping offset still-insipid domestic demand and bringing the country’s latest two-year recession to an end, while a much-improved trade balance has also helped raise prospects for the French economy.
The favourable GDP numbers tallied with other data showed a strengthening European economy. Industrial output in the eurozone rose during the second quarter at its fastest pace in more than two and a half years. The pick-up in manufacturing meant that Markit’s purchasing managers index (PMI) of eurozone businesses indicated the first, albeit faint, rise in activity for 18 months in July. Meanwhile, there have been signs that some troubled banks are slowly returning to profitability and bolstering their capital structures, while fiscal reforms continue apace in many large countries in a bid to reduce budget deficits.
Outside the eurozone, UK GDP grew by 0.6% in the second quarter (equivalent to a yearly growth rate of 1.4%), thanks to the strong performance of the dominant services sector. Indeed, the UK services sector has continued to grow into the third quarter. The sector expanded at its fastest pace in more than six years in July, topping even the most optimistic forecasts, while the PMI reading for manufacturing in July was the strongest reading since March 2011, beating economists’ forecasts by a wide margin. This revival in economic fortunes has been posing something of a dilemma for policymakers, although the new Bank of England chairman, Mark Carney, has decided the central bank can do more to help ensure that growth momentum is maintained by issuing US Fed-style “forward guidance.” Pointing out that the recovery in output since the financial crisis of 2008–2009 was the slowest “on record,” Carney seemed to commit the Bank of England to loose monetary policies for quite some time yet. In a similar departure from central bank orthodoxy, the ECB has also been seen to commit itself to “forward guidance” in recent weeks. In a bid to put recent growth on a firmer footing, the ECB’s president, Mario Draghi, stated in July that he expected to keep ECB policy rates at their current or lower levels for an extended period of time.
But the Bank of England’s concerns about the fragility of recent signs of an upturn in growth are valid for the eurozone as well. There are definitely signs of stabilisation, but eurozone GDP at the end of June was still 0.7% lower than it was a year earlier, and it is not yet clear that we will see a rapid and sustainable economic recovery in the eurozone any time soon. There are still many factors that are preventing a broad-based recovery from taking hold, such as ongoing private-sector deleveraging and the divergence of public-debt ratios in many countries. Unemployment remains staggeringly high in many countries, and bank lending—especially to corporations—is terribly weak as Europe’s biggest banks cut assets and seek ways to generate fresh capital to comply with tightened capital-adequacy regulations. One major institution, for example, has announced plans to shed €300 billion in assets (equivalent to about one-fifth of its total assets) to relieve pressure on its balance sheet. Other big banks are also trying to down-size—a trend that has been contributing to weak business investment in much of Europe.
An equally important question is whether Europe’s tentative spurt of growth is balanced. We have yet to see the UK moving away from an economic model driven by a bloated banking sector and fuelled by credit-financed domestic consumption, for example. As for the eurozone, the recent rebound in industrial production has been heavily concentrated in Germany. A currency zone dependent on the economic prowess of just one of its constituent members will remain vulnerable.
To these factors may be added renewed fears about the stability of an Italian government facing budget talks in the weeks ahead and fears over the repercussions of the slowdown in major emerging markets, while the rise in long-term interest rates in the US could spill over into Europe, putting renewed pressure on companies and some troubled eurozone countries. At the same time, there is persistent talk of a further restructuring of Greece’s huge debt burden (where the government’s debt-to-GDP ratio reached 160.5% of GDP at the end of the first quarter of 2013, according to Eurostat). True, by holding out the possibility of unlimited intervention through its “outright monetary transactions” (OMT) programme, the ECB has bought eurozone leaders time to find a sustainable solution to the sovereign crisis that has threatened to engulf southern Europe over the past three years. But the OMT remains untested. Alarm bells would start ringing should talk of a Greek restructuring extend to other countries such as Portugal.
