It is widely expected that the flash estimate of euro zone GDP in Q2, due to be published on Wednesday of this week, will show a return to expansion across the single currency bloc. According to a poll by Thomson Reuters, the median forecast among economists was for growth of 0.2%. But will growth prove sustainable?
If expectations are fulfilled, this week’s data will bring to an end six consecutive quarters of declining output. It goes almost without saying that growth will have been concentrated in the core nations. Data for Italy and Spain were published last week, and these showed falls in output of 0.2% and 0.1% respectively. Still in negative territory, but an improvement on the figures for Q1.
The fall in peripheral yields following Draghi’s commitment last summer to do ‘whatever it takes’ to save the single currency has taken some of the pressure off the indebted sovereigns, for now at least. And the peripheral nations have started to rebalance their economies. When the expenditure breakdown becomes available, it is likely to show a rising contribution to growth from net trade in Portugal, Ireland, Italy, Greece and Spain. Net trade often acts to boost growth in a recession, as imports fall faster than exports. However, digging a little deeper, we find some encouraging signs. The peripheral nations are starting to export a greater proportion of all that they produce, and to import a declining proportion of all that they buy. What would greatly facilitate adjustment, however, would be if the surplus nations, most notably Germany, were to raise their domestic consumption and import more. Each month, the Bundesbank publishes an estimate of retail sales in Germany. After adjusting for changes in prices, it is striking that the volume of retail sales in Germany is lower now than it was when the index was first published, almost 20 years ago.
The euro zone’s Achilles Heel remains its banking system. In spite of all the talk about a Banking Union, a toxic link persists between under-capitalised banks and their over-indebted sovereigns. As we set out in our latest quarterly forecast, the biggest risk for the single currency bloc is that a reduction in the pace of QE by the Federal Reserve has spillover effects, forcing up sovereign yields across the euro zone. That would put peripheral government finances under renewed pressure, and lead to significant falls in banking sector assets. Right now, Continental Europe needs a policy tightening like a hole in the head. The danger, however, is that with wholesale QE â€“ as distinct from OMTs focused on individual nations â€“ likely to be regarded as unconstitutional by the Germans, the ECB may have nothing with which to fight back.
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