Weak euro activity in Q2

The euro area economy stagnated in Q2 and was thus weaker than expected. We believe that a number of temporary factors affected the economy negatively in Q2.

• The slowdown in the US and China in Q1 is likely to have had a lagged negative impact, but this should continue to fade after the US had strong growth of 4.0% q/q ann. in Q2 while China is also strengthening.

• The strengthening of the currency during 2013 has a lagged negative impact on domestic output as it led to a deterioration in price competitiveness, which reduces exports and raises imports. However, after the ECB in May signalled that it would ease monetary policy in June, the exchange rate has weakened and the headwind from the worsening of price competitiveness has started to fade although it will take time.

• Geopolitical tensions are likely to have negatively affected business sentiment. This could imply that some enterprises are likely to have adopted a wait-and-see approach, which mainly has a negative impact on investments and employment. As long as the uncertainty continues, this is likely to be a factor, but we believe an escalating trade war would be unbearable for both Russia and the EU and that the EU will revoke the sanctions within one-three months, with Russia abolishing its own sanctions.

On the other hand, private consumption is likely to have continued to contribute to economic activity as retail sales increased during Q2. Looking ahead, the decline in inflation in Europe should support private consumption as it has mainly fallen due to lower commodity prices, implying it increases real wage growth.

Stronger growth in private consumption will also be the engine for businesses to start increasing investments going forward. This follows as higher demand for goods creates scope for expanding capacity and in that way it could counteract some of the weakness related to uncertainty about geopolitical risks.

Moreover, the latest lending figures show that a significant headwind is slowly fading. Together with the ECB’s easing measures announced in June, we believe lending will continue to improve, which is much needed to take the recovery to the next level. Our view follows as the ECB’s Bank Lending Survey shows that demand for credit is increasing, which is one factor, which is necessary for the cheap funding to feed through to the real economy.