Euro Could Face Downside Risks as German Economy Struggles to Stay Afloat

Published July 21st, 2008 - 06:53 GMT

The Big 4 in Euroland have responded rather differently to the headwinds that have hit the Euroland economy. Overall, Euroland is on the brink of recession. The French economy is cooling very fast at the moment, as indicated by the composite PMI falling from above 55 to below 50 in just 3 months, meaning French PMI has entered contraction territory. In addition, French consumer confidence is in freefall, hitting a record-low for the sixth straight month in June. In Italy, growth has been slow for years, and Italy has been well into PMI contraction territory for some time. Spain is in deep trouble, and is set to slide into recession this year on the back of the collapsed housing market, which hadbeen the main driving force for growth in recent years. Germany, in contrast, has performed relatively well during these turbulent times, and is now more or less the last man standing in Euroland. Therefore, Euroland growth heavily depends on how Germany copes with the blows it has been dealt. If Germany weakens (further) in the coming months, this will have a profoundly negative effect on the Euroland economy, as Germany accounts for more than a quarter of total Euroland GDP. Furthermore, as the Euroland economies are rather intertwined, a weakening in Germany will most likely have a substantial knock-on effect on the other Euroland economies - and the risk of a significant economic slowdown in German has risen in recent months, as the other major economies in Euroland have weakened considerably.

Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank



Weekly Bank Research Center 07-21-08



 

Ranking the Top Commodity Exporters

Stephen Roach, Head Economist, Morgan Stanley

Most commodity prices have remained buoyant, somewhat in contrast to decelerating global demand growth. It is likely that supply and demand, as well as investment flows, have all contributed to these trends. The future trajectories of the key commodities such as crude oil, base metals and soft commodities remain controversial and uncertain. Oil prices, in our view, are key for monetary policy and fiscal policy, and act as a major source of wealth transfer between economies. Further, the oil price rise is likely to have significant medium-term effects on the growth prospects of some Asian economies. Setting aside the factors driving commodity prices and the impact on the global economy, the focus of this note is to carefully rank the commodity-exporting countries on how commodity-intensive and reliant they are. Further commodity price increases would obviously have positive effects on these economies, while major price declines would have negative effects on them.

 

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Germany Setting the Pace for Euroland's Economy

Niels-Henrik Bjørn Sørensen, Senior Analyst, Danske Bank

The Big 4 in Euroland have responded rather differently to the headwinds that have hit the Euroland economy. Overall, Euroland is on the brink of recession. The French economy is cooling very fast at the moment, as indicated by the composite PMI falling from above 55 to below 50 in just 3 months, meaning French PMI has entered contraction territory. In addition, French consumer confidence is in freefall, hitting a record-low for the sixth straight month in June. In Italy, growth has been slow for years, and Italy has been well into PMI contraction territory for some time. Spain is in deep trouble, and is set to slide into recession this year on the back of the collapsed housing market, which had been the main driving force for growth in recent years. Germany, in contrast, has performed relatively well during these turbulent times, and is now more or less the last man standing in Euroland. Therefore, Euroland growth heavily depends on how Germany copes with the blows it has been dealt. If Germany weakens (further) in the coming months, this will have a profoundly negative effect on the Euroland economy, as Germany accounts for more than a quarter of total Euroland GDP. Furthermore, as the Euroland economies are rather intertwined, a weakening in Germany will most likely have a substantial knock-on effect on the other Euroland economies - and the risk of a significant economic slowdown in German has risen in recent months, as the other major economies in Euroland have weakened considerably.


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Below Trend Global Growth in 2009

E. Silvia, Ph.D. Chief Economist, Wachovia

Global real GDP growth averaged nearly 5 percent per annum between 2004 and 2007, the strongest four-year period of growth in decades. However, real GDP growth rates have slowed in most countries thus far in 2008, and we look for further deceleration ahead. Indeed, global GDP growth should fall below its long-run average next year, making it the slowest year for global growth since 2002. Although global growth should slow further, the probability of a global recession is rather low because economic fundamentals in many countries, especially in the developing world, are much stronger today than in previous cycles. Slower growth is starting to show up in other economies as well. For example, economic activity in the United Kingdom is the weakest it has been since 2001, and monthly indicators suggest growth in the Euro-zone slowed significantly in the second quarter. The Japanese economy appears to have stalled, and most large developing countries have not been immune from slower growth. Why has growth slowed abroad? First, exports to the United States from many countries have weakened. Second, dislocations in credit markets since last summer have weakened growth in countries that are extensively financed via capital markets and/or experienced significant run-ups in house prices. Third, the sharp rise in the price of oil is eating into real income in many countries, leading to slower growth in consumer spending. Finally, central banks in many countries have tightened monetary policy in response to rising inflation rates that have been engendered by the sharp rise in the price of oil.

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Bank of Canada Lays Their Cards on the Table

Steve Chan, Economist, TD Bank Financial Group

In Canada all eyes were on the Bank of Canada who in addition to their interest rate decision released an update to their April Monetary Policy Report. While markets were caught off guard last month by the Bank’s decision to leave interest rates unchanged (when a cut was largely expected), this month’s decision to leave the overnight rate at 3.0% came as no surprise. In their communiqué and MPR, the Bank stated that of the three risks to their inflation outlook – a slowing U.S. economy, ongoing financial market turbulence and rising commodity prices – it was the third that had caught them most off guard. As a result of rising energy prices the Bank raised their forecast for CPI inflation to a peak above 4.0 % in the first quarter of next year – doubling their previous forecast in April. The Bank also revised their forecast for GDP growth, lowering 2008 growth to 1.0% from 1.4% previously and 2009 growth slightly to 2.3% from 2.4% previously. Overall the Bank maintained its neutral stance, stating that it judges the current risks to the inflation outlook to be roughly balanced and that the economy should begin to show considerable improvement through the first half of 2009. Still, given the ongoing stresses on the U.S. economy and recent signs that the domestic Canadian economy is also slowing we believe the state of economic weakness is likely to be more protracted than what is expected by the Bank. As a result, we continue to expect the Bank of Canada to remain on the sidelines, leaving interest rates unchanged at their current level until the second half of 2009.

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Scenarios Highlight Risk of UK Recession

Trevor Williams, Chief Economist at Lloyds TSB Financial Markets

With the credit crunch now taking second place to worries about inflation, interest rate futures are pointing to significantly higher official UK interest rates in the next two years than they were a few months ago. But the rise in consumer price inflation to 3.3% in May and the prospect that it will peak at well over 4% this year has led to a sharp change in sentiment in the financial markets. Moreover, UK consumers seem immune to the pressure from rising inflation, higher mortgage borrowing costs, falling house prices and lower confidence. Retail spending refuses to fall, rising by 3.5% in May to stand 8.1% higher in volume terms than in the year before. Our view is that employment growth is the key to this as some people give up on owning a home, or moving near term, and spend instead, leading to lower savings and strong growth in sales. With inflation rising, there is a clear risk that the MPC may be forced to raise official interest rates significantly higher, despite weaker overall growth. Because of this, we have calculated two scenarios, one where interest rates move in line with financial market expectations, as suggested by forward sterling interest rates, and a second where Bank rate is 2% higher than in our base case. The base case assumes only one increase in UK official interest rates, in early 2009 when the effects of the credit market crisis are fading and the implications of higher consumer price inflation for the economy are clearer. The results of this exercise are shown in the following charts. And the outcomes are clear: the Bank of England must be careful not to raise interest rates too much too soon. Such an outcome could make the unfolding economic slowdown too excessive, and lead to consumer price inflation undershooting the official 2% target in 2010. At the same time, our analysis shows that some increase in official interest rates seems necessary for inflation to hit the 2% target. But for that to happen, a period of below trend growth (2.3-2.6%) this year and next is not only desirable but also necessary.

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