• Disappointment. The euro zone is once again lagging behind. While real US GDP at the end of 2009 posted its strongest growth since the beginning of 2005 at 6% annualized, the European economy made virtually no headway. Even worse, the breakdown of the demand components released last week shows that exports were the sole growth “driver“. Not even the inventory cycle was able to generate impulses. 

  • Expectation. And the prospects are not intoxicating. A sustainable recovery requires support from final domestic demand. But it is not expected to reverse trend until 2011. Private consumption is suffering from the poor labor markets coupled with the end of the auto scrapping schemes, while investment activity is adversely affected by bleak sales prospects as well as low capacity utilization rates. At the same time, global trade is losing momentum again. 

  • Winter! Currently, the exceptionally cold and long winter is becoming an additional drag on first quarter growth. According to our calculations, it will cost up to 0.3 percentage points. It is, therefore, quite possible that European growth will tread water in 1Q10 (pages 2-3). For the US, in contrast, we expect GDP growth of no less than 2¾% annualized.

  • Spring? Undoubtedly, the stronger the drag now – the more pronounced the technical rebound in 2Q10. Experience shows that the construction shortfall is quickly made up. But even that will not be enough for a true spring awakening. In 2010, real GDP will on average eke out meager growth of only 0.9% – half of which will likely come from the statistical overhang.

  • Further topics:

    – Switzerland: On track for a sustainable recovery (page 4).

     – Oil price will continue to tend higher (page 7).

     – Data outlook: ZEW growth expectations to post a renewed decline; US production & leading indicators down again (page 9). 

    – Market outlook: Euro stabilizes (page 18).


EMU: A sub-par recovery ahead

  • EMU GDP in 4Q09 was up a meager 0.1% qoq, down from the 0.4% recorded in 3Q. Domestic demand remains particularly weak, with foreign trade being the only growth driver in 4Q. The recovery still lacks sustainability.

  • Private consumption was flat at end-2009. While the free-fall has come to an end, we don’t expect a genuine recovery in household spending anytime soon, probably not earlier than 2011.

  • Fixed investment remains under pressure, due to still poor capex fundamentals and an ongoing drop in construction – now exacerbated by cold weather. Like in the case of consumption, the turning point should come only next year. 

  • Exports are the only variable that shows good momentum and has indeed surprised to the upside of late. However, as 2010 progresses, we think that a moderate slowdown is more likely than a further acceleration, as world growth has probably already peaked.

  •  Due also to adverse weather conditions, prospects for 1Q10 seem to be for another dismal growth performance, possibly not too different from the one recorded at end-2009. For 2010, we stick to our forecast of 0.9% GDP growth, with an acceleration to 1.3% in 2011.


Poor domestic demand

EMU-wide GDP in 4Q 2009 was up only 0.1% qoq, and details on the expenditure side published by Eurostat last week were broadly as we had anticipated. In a nutshell, domestic demand remains particularly weak, while foreign trade is currently the only growth engine. In other words, the recovery still lacks sustainability.

In 4Q, private consumption was flat on the quarter, after a 0.2% contraction in 3Q. These data support our view that household spending has now entered a phase of stabilization, after having declined at a 2-2.5% annualized pace between end-2008 and early-2009. But this is the end of the good news. As a matter of fact, an acceleration in households spending in the course of 2010 remains unlikely, for several reasons. First of all, employment is still falling and should flatten out only at the end of the year. This factor alone would be sufficient to rule out any tangible improvement in private consumption in the near term. Second, inflation has risen from the lows, even though we acknowledge that the upward trend is mainly driven by the base effect on energy, while core prices actually keep slowing. Moreover, car purchases are now turning into a drag, as the steep drop already visible in France (and expected in Italy in the coming months) should more than offset signs of stabilization in the German market. In our projections, consumption turns again negative in 1Q10 mostly on falling car sales, and shrinks marginally on average this year. Signs of peaking in the savings ratio, consistent with the moderate recovery trend in consumer confidence, should not be enough to steer the consumption trend towards a recovery. We expect this to occur only in 2011.

Government spending contracted 0.1% qoq, marking the first quarterly drop since 1999. In our forecasts, this expenditure component in 2010 and 2011 expands at a rate that is well below the long-term average, given that the public sector will increasingly need to cut purchases of goods and services to reverse the deficit trend, and keep wage growth under strict control – in some periphery countries like Greece and Ireland, public sector nominal wages will fall outright.

Fixed investment declined 0.8% qoq, the seventh consecutive drop. We don’t know yet the drivers of the decline, but the bulk of weakness should have been in construction, as flagged by the 1.4% drop in construction output in the quarter. In our view, capex was probably only moderately negative, confirming signs of tentative stabilization seen in 3Q. Looking ahead, as capex fundamentals have not yet improved sufficiently – firms are still deleveraging and capacity utilization rates remain depressed – and the downward adjustment in construction activity has more way to go, fixed investment will probably weaken further this year. As in the case of private consumption, the recovery will probably only come in 2011.

The only good news is the resilience of exports, which were up 1.7% qoq at the end of last year after a 2.9% gain in 3Q. Import growth slowed to 0.9% qoq (vs. 2.8% in 3Q), leaving the net export contribution at +0.3pp. The inventory contribution was flat (after +0.5pp in 3Q) as the pace of de-stocking remained unchanged vs. the previous quarter. This is a bit disappointing if we consider that the turn of the inventory cycle was supposed to be a key growth driver in the first stages of the eurozone recovery. However, as new orders keep on a rising trajectory and all business surveys hint that inventories have already been cut aggressively, we haven’t lost hope that de-stocking will eventually slow down, therefore providing support to overall economic activity in the coming quarters.


GDP to disappoint also in 1Q, but bad weather weighs

Let’s now come to the near-term outlook. The prospects for 1Q are for a continuation of the modest recovery trend, but with a big question mark on the dampening effect of bad weather, particularly on constriction activity. While business surveys suggest that the underlying pace of GDP growth is currently about 1.2%-1.5% annualized and that momentum in foreign demand is strengthening further, unusually cold weather probably will have a very visible impact on the final GDP outcome. This is suggested by the whopping 14.3% drop in German construction output in January and the steep decline in retail surveys across the area in February. Currently, we still expect 1Q GDP growth in the eurozone to settle at 1% annualized, but our gut feeling is that risks are shifting to the downside. We fear that the impact of cold weather on construction could shave up to 0.3pp off eurozone quarterly GDP, and if this were to be the case, a GDP outcome in line or even below the disappointing 4Q reading should not be ruled out. However, the weather-related distortion needs to be seen as short-term noise, and a prompt technical rebound has to be expected during the spring, when the GDP dynamics will probably resume accelerating. In general, it’s pretty safe to affirm that the larger the setback in 1Q, the stronger the bounce-back in 2Q.

All in all, net of short-term volatility, neither the 4Q09 GDP report nor the first hard data available so far in 1Q have challenged our view that the eurozone recovery continues to lack sustainability. We keep expecting average GDP at 0.9% this year and 1.3% in 2011, still somewhat below consensus.