Summary
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The euro zone caused a bit of a surprise when its real GDP figures for Q2 were released. While the zone as a whole registered a slight contraction already in contrast with the situation in the United States, Europe’s largest economy, Germany, recorded a slim increase in activity.
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Though the euro zone has suffered a much deeper production shock than the United States, the collapse in real GDP does not seem to have wreaked havoc in its labour market.
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Germany provides a flagrant case in point. Despite a drop in production of 6%, nearly twice as much as in the United States, employment has retreated only 0.5%, almost one-tenth what it has in the United States.
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The European labour market is far behind its U.S. counterpart in its adjustment to the recent economic recession. Consequently, employment in the euro zone has considerable downside potential and this constitutes a serious risk to future consumption growth.
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Despite the fact that the real GDP shock was more serious in Europe than in the United States, the ECB proved less intrepid than the Fed, leaving its real key rate higher and increasing its balance sheet less aggressively.
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If we are right in our prediction that the United States will experience a more vigorous cyclical rebound than Europe next year, we believe then that the Fed will lead the way among the G7 central banks in raising interest rates and that the ECB will instead bring up the rear.
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All this should in principle lead to a depreciation of the euro against the greenback. Hence, we expect to see the euro at 1.25 in 12 months.
