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Turning point

Thu, Aug 14 2008, 14:51 GMT
by Yapi Kredi Bank Economic Research Department

UniCredit Group

The recent wave of data has marked a turning point in the global outlook, and even more so in the market’s perception of the global outlook. European growth has suddenly stalled, with all three major countries contracting in Q2 and leading indicators flagging a material risk of a technical recession. Japan and the UK are in a similar predicament, and emerging markets are also showing signs of weakness. The markets have quickly embraced the view that the slowdown is migrating from a surprisingly resilient US to the rest of the world, and we therefore seem to have reached a turning point, potentially marking the end of the golden age for commodities and for the euro. I have argued since the onset of the crisis that full decoupling was an illusion, and I have long maintained that commodities were experiencing a bubble—but I would caution at this point that the adjustment ahead is unlikely to be smooth. Bullish sentiment on the US will be challenged again before we see the next decisive leg of the USD rally; commodities are not dead and will trigger further volatility; and the ECB and BOE will not be as quick as the markets to dismiss the inflation threat (I think markets yesterday were too quick in branding as dovish Mr. King’s pragmatic assessment of the UK outlook, ignoring all references to rising inflation risks).

Today’s Q2 GDP releases have vindicated our long-held view that the Eurozone would inevitably succumb to the mounting headwinds. The slowdown in global growth is undermining external demand for Eurozone exports, still hampered by the past rise of the Euro; consumers are on the defensive due to both the financial crisis and the higher food and fuel prices, and monetary conditions remain relatively tight to fend off potential broader inflationary pressures. Eurozone GDP contracted (by -0.2%) for the first time since the launch of the EUR; and while the decline in Germany (-0.5%) was not as sharp as feared, it was matched by a contraction in the other two largest countries, France and Italy (both by - 0.3%) and Spain barely in positive territory (+0.1%)—the four largest countries together account for nearly 80% of Eurozone GDP. The downswing is broad-based, and the close trade links within the Eurozone could make it self-sustaining. Leading indicators such as the PMIs suggest that the downward trend is still ongoing, flagging a material risk of a technical recession. Core inflation meanwhile ticked down to 1.7% in July, confirming that the economic downturn is negating second round effects from the food and fuel price shock.

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Published on  Thu, Aug 14 2008, 14:53 GMT