The cautious and somewhat self-deprecating tone of Axel Weber’s comments today speaks volumes: even eurozone policymakers remain prudent in the face of the surprisingly strong 2Q growth figures, as the stronger initial rebound cannot dissipate doubts and concerns over the sustainability of the recovery. I had flagged in previous notes that near-term risks were skewed to the upside, and I believe that remains the case, as the turn-around in the inventory cycle and the stronger than expected rebound in global trade suddenly kick-start economies turbo-charged by powerful fiscal stimulus. Don’t get me wrong: 2Q data are genuine positive news, which confirm the buoyancy of the Asian growth story and scale back downside risks to the global recovery. But with the US outlook still shaky, strong Asian growth is not enough to guarantee robust and sustained global growth. By the end of this year the rebound in inventories and global trade will lose momentum, and fiscal stimulus will remain the main support to G10 growth against a fragile outlook for household consumption and the risk that anemic credit supply might restrain investment. Reports of the death of the global economy were greatly exaggerated, but we should not already be looking for a clean bill of health. Recent data justify relief, not euphoria. Policymakers will maintain a supportive fiscal and monetary stance—exit strategies are definitely not around the corner—while trying to set market expectations on an even keel. Investors, however, will inevitably be more prone to enthusiasm and disappointment, with volatile macro data setting the stage for a roller-coaster ride on equities and other risky assets in the coming months.
In an interview to the German paper Die Zeit, the Bundesbank’s President said he is not yet convinced that Germany’s recovery can be sustained; he noted that the 2Q rebound owes much to the support measures deployed by the government and by the ECB, and argued that policy stimulus should be maintained for the time being, with a monetary exit strategy to be implemented only once the recovery appears sustainable and financial markets have stabilized to a sufficient degree.
European 2Q GDP data released last week raised hopes that (1) the global recession is over; (2) the recovery will be smoother and stronger than anticipated; and (3) Europe is sprinting ahead of the US to lead the G10’s recovery. The first point is not much of a surprise, but the second and third would turn the existing consensus upside down: there is an intimidatingly robust academic literature showing that recessions accompanied by a financial crisis tend to be especially deep and long-lasting, and nearly all economic forecasts out there were predicting a deeper downturn and a later recovery for Europe than for the US. Against this background, European policymakers could have rushed to boast that the natural order of things is being restored, with virtuous eurozone countries already back on their feet while the sinful US and UK still bite the dust.
European policymakers, however, have visibly refrained from gloating, and with good reasons:
While recent European data have surprised on the upside, US developments remain mixed, with disturbing signs of persistent weakness in housing, employment, and household spending. In order to enjoy a V-shaped recovery, therefore, Europe would need to decouple from the US. How realistic is this prospect?
The eurozone, and Germany in particular, is benefiting from the stronger than expected rebound in Asia: the recent upward revision to our eurozone growth forecasts reflects in good part a stronger expected contribution of net exports in the second half of this year. The Asian recovery story is a genuine and structural strength of the current global economic outlook. While China’s growth is in part inflated by excess credit growth, there is no doubt that we are witnessing the beginning of the rebalancing of Emerging Asian growth towards domestic consumption, and that a number of Asian economies are reaping the benefits of having entered the crisis with sound financial sectors and strong fiscal positions.
Asia, however, is not yet strong enough to pull the rest of the world economy along, and Asia alone cannot ensure a sustained and robust recovery in Europe. Germany, which is the eurozone’s export champion, depends on Asia for only 15% of its exports, compared to about 65% of German exports heading to the rest of the EU (including Central and Eastern European member countries). And while Germany and France have surprised on the upside in 2Q, other important eurozone economies like Italy and Spain remain mired in recession.
If demand from the US is not strong enough and demand from Asia is not large enough to pull the eurozone along, the sustainability of the European recovery then hinges on domestic demand. Public spending will play an important role over the coming eighteen months, and has already been instrumental in pushing France and Germany out of recession. But there is no political appetite for further fiscal stimulus, and the fiscal impulse will therefore have to weaken towards the latter part of next year. Household consumption, on current trends, is unlikely to become a powerful engine of growth in the near term.
The persistent fragility of the financial sector is a further source of concern. The normalization process is gradually underway, and the ECB’s bank lending survey is now pointing to some improvement in the credit outlook. But, notwithstanding the ECB’s sizable injections of liquidity, credit growth has continued to decelerate as banks brace themselves for the projected increase in defaults on corporate and household debt. The risk that anemic credit supply might restrain investment is still real.
