Eurozone economy picking up some momentum
Economic statistics have been proving surprisingly encouraging in Europe over the last few weeks. The upturn can be put down to the lower oil price, weaker euro, an end to austerity and a shift in the ECB’s monetary-policy regime.
If we look back to our core economic scenario outlined in November last year, three of the key developments we had pinpointed already materialised in January this year: firm anchoring of US growth; quantitative easing at the European Central Bank (ECB); resurgence of systemic risk in the eurozone. On the latter score, the constructive talks between Greece and the Eurogroup took some of the heat out of the situation in February.
Crude oil: still a major supportive factor
After slumping by over 55% from its peak, the price of a barrel of WTI crude oil levelled out at $50 in February. That lower level is delivering benefits for the global economy. Consumer spending is perking up on the back of increased purchasing power. The US economy is more sensitively geared to these benefits than its European counterpart. A gentle rebound in the oil price should, however, be on the cards.
The eurozone economy is being boosted by the fall in the euro’s value, as it responds to the shift in the ECB’s monetary regime, involving a move from ZIRP to NIRP (zero to negative interest-rate policy) and quantitative easing (€60bn a month for at least 18 months). The size of the pool of assets the ECB might potentially buy, however, will diminish automatically as yields float lower. Let us take an example: the size of the euro-denominated investment-grade corporates segment on negative yields has more than doubled from €800bn in 2014 to €1,700bn today. Moreover, the eurozone economy is being underpinned by an end to austerity in several countries. Systemic risk has reduced in response to the constructive talks between the newly elected Greek government and the Eurogroup.
The US economy has been regaining momentum, but is still going through a spell of transition. Households and businesses alike have started to borrow again. Inflationary pressures are still subdued though. Headline inflation is running at around -0.1% y-o-y and core inflation is in positive numbers at 1.6% y-o-y. This gap is set to persist for a while. We would, however, expect the headline rate to trace out a V-shaped rebound. Economic fundamentals are, therefore, slowly beginning to warrant a tightening of monetary screws. The precise scheduling of the rate hike is still hard to predict. The markets are working on a Fed funds rate of 0.5% by end-2015 while average rate projections for the Fed’s Board of Governors are pitched at 1%.
In order to keep China’s economic growth cruising along at close to 7%, the authorities in Beijing are likely to adopt a stop-go approach to economic policy. The slowing property market is acting as a brake on growth. An ageing population and rising pay are also further drags.
Japan’s economy pulled out of its recession in Q4 2014. Monetary policy predicated on ongoing quantitative easing, reflationary budget and fiscal initiatives, and structural reforms on an unprecedented scale are beginning to feed through.
US: Janet Yellen paving the way for rate hikes this year
The estimate of US GDP growth in Q4 2014 was revised down from 2.6% to 2.2%. Moreover, economic numbers released for January and February this year were often on the disappointing side, the notable exception being January’s employment report. The strengthening dollar has begun to curb US export growth and apply a brake to manufacturing output. Furthermore, this turn of events has been temporarily exacerbated by major disruption to the working of America’s main West Coast ports. On the household front, robust growth in wages and tumbling petrol prices gave real disposable income a handsome boost (annualised rise of 8.5% between Q4 2014 and January 2015), but, to date, this has not produced much more than a modest upturn in consumer spending (up 2.7% over the same period). This impressive increase in real purchasing power should, however, continue to bolster consumer spending in the coming months, as should the strong jobs growth and upbeat consumer confidence. As a result, even though, statistically, it has been a rather drab start to 2015, we remain optimistic about the US economy’s growth prospects for this year.
Fed Chair Janet Yellen’s recent testimony to Congress confirmed that the ‘patience’ watchword, implying no hike in the Fed funds rate likely to be pushed through at the next two meetings of the Federal Open Market Committee (FOMC), would probably be dropped in the Fed’s next policy statement (due for release on 18 March). In theory, this likelihood opens the door for the Fed funds rate to be lifted from June. The Fed Chair did, however, point out that the change in language did not necessarily mean short-term rates would be raised in June, but merely indicated that such a hike would start being considered “on a meeting-by-meeting basis”. The final decision will hinge on what is happening to the economy and, in particular, on the FOMC’s confidence that inflation is moving back up towards the 2% mark. We stick with our belief that, under the most plausible scenario, the Fed would make a start on lifting its interest rates from June, but the chances of the Fed postponing the onset of its rate hikes can be far from discounted.
Eurozone: signs of the economy swinging upwards proliferating
The latest findings from eurozone economic and business surveys suggest Q1 2015 has been stronger than late 2014. The Markit Composite PMI, measuring activity in manufacturing and services, climbed for the third month in a row in February, posting its highest level, at 53.5, since May 2014. As for households, the increase in real disposable income on the back of lower oil prices, together with signs of the jobs market stabilising, would seem to be fuelling an upturn in consumer spending. On this score, the most recent retail sales figures for Germany recorded their biggest monthly jump (+2.9% in January) since September 2008.
The latest data on lending and monetary aggregates have also provided evidence that things are improving. Real growth in M1, one measure of the money supply and regarded as a leading economic indicator for the eurozone, has unmistakably quickened to run at its fastest pace (+9.6% y-o-y) since February 2010. In parallel, lending volume to the private sector fell by 0.1% y-o-y in January, a much smaller drop than in previous months. Looking ahead to the next few months, the onset of the ECB’s quantitative easing, along with the latest Targeted Long-Term Refinancing Operations (TLTROs), should ensure liquidity stays in plentiful supply. The hope of finally seeing this liquidity being converted into loans has been boosted by recent signs of a brightening economic outlook. The eurozone can thus possibly draw on another factor of support, one that has been cruelly lacking for several years.
On the political front, the road ahead still stretches far into the distance despite the deal struck between Greece and the Eurogroup over a four-month extension to financial assistance. In the near term, there are still nagging doubts as to whether Greece will be capable of honouring its first repayment deadlines in March. There are several options available to avoid a default: the Eurogroup could decide to disburse funds or authorise Greece to raise its debt issuance ceiling, capped at €15bn. For such concessions to be granted though, political leaders in Athens would need to show willing with tangible efforts. Pressure being exerted on the Greek government is set to remain intense.
China: second cut in benchmark interest rates
Three months after first lowering its key interest rates and one month after the first reduction in banks’ statutory reserve ratio, the People’s Bank of China (PBoC) announced in early March that it was trimming its two benchmark interest rates a second time (by a quarter-point in both cases). These cuts are aimed at underpinning economic growth, but the purpose is also to avoid a rise in interest rates in real terms stemming, partly, from the recent slowdown in inflation (0.8% in January) and, partly, less money being created as a result of the halt being called to traditional interventions on the currency markets as the Chinese yuan has been drifting downwards against the US dollar.
The PBoC’s recent monetary policy initiatives are not, however, likely to be enough to pull China’s economy around effectively from its recent bout of weakness. Further monetary easing will probably have to be implemented in the months ahead. Efforts being made by the Beijing authorities to halt the economic slide, when set alongside the beneficial impact from lower oil prices and slightly more robust global growth, should bear fruit and growth should level off. We still expect GDP growth in China to work out at 7.0% in 2015, down from 7.4% in 2014.