Eurozone trade struggles to emerge from slowdown – Monetary Occasions

Green shoots are showing in Europe’s manufacturing sector after a torrid year — but it is probably too early to call an end to the slowdown.

Industrial production expanded month on month in all five of the eurozone’s largest economies in May, a welcome relief given the gloom that has shrouded the bloc’s manufacturers in the past year.

Economists polled by Reuters expect to see a 0.2 per cent month on month expansion of industrial production across the eurozone when May’s figures are published on Friday. That would be the best performance since January. However, the European Commission warned on Wednesday that the bloc’s economy faces a “host of negative risks”, citing manufacturing in particular for the “downgrade” in momentum.

It forecasts growth of 1.2 per cent this year, which would be the worst performance since 2013.

The first tremors were felt last summer in Germany’s car industry — vehicle production dropped by nearly 10 per cent between June and August 2018. Then over the following months what began as a localised problem fuelled by structural changes in a particular industry evolved into a pan-European industrial downturn that threatened the bloc’s six-year growth run.

The timing for the European Central Bank was terrible. As German industry showed its first signs of weakness, Mario Draghi, president, signalled that he was preparing to ease back on the stimulus measures which had been in place for the past three years.

Mr Draghi was convinced that they had worked well enough to secure the bloc’s economy. But that proved not to be the case. Having forecast 2019 GDP growth of 1.9 per cent in the middle of last year, the ECB cut it in December last year to 1.7 per cent and then cut it again in March this year to 1.1 per cent.

The problem is still most concentrated in manufacturing. German industrial output expanded by 0.3 per cent month on month in May, but is still down by more than 4 per cent on a year earlier — the steepest contraction since the financial crisis.

“German industry remains in a serious slump and is prompting a further downward revision for the euro area as a whole,” said Bruce Kasman, head of economic research at JPMorgan.

The slowdown has since spread — partly via automakers’ supply chains — to manufacturing more widely. Motor vehicles are the worst performing sector across the eurozone, but the slump is also affecting industries such as machinery production, reflecting businesses’ reluctance to invest.

When economists first noticed last year that Europe’s factories were struggling, they blamed a host of “one-off” factors, from the introduction of new EU emissions standards to low water levels on the Rhine. Turkey’s recession made things worse, and the dynamics of the global economy have also contributed — a factor that is likely to persist.

“Trade tensions have led to a global slowdown of demand for investment goods,” said Stefan Schilbe, chief economist at HSBC in Germany. “If world trade grows strongly, Germany benefits disproportionately but if times are difficult, the lack of demand for investment goods hits Germany harder than other countries.”

Machinery and equipment production fell by 2.5 per cent year on year in Germany in May, and by 1.8 per cent in Italy. This is the largest industrial export sector for both countries, as it is for the eurozone as a whole.

France by contrast, which is not as exposed to the fluctuations of global trade, has been less affected. Real output in French manufacturing expanded by 3.4 per cent year on year in May, figures published on Wednesday showed.

“Other economies in the eurozone have so far been more insulated from global weakness because of stronger domestic demand and because their comparative advantages may be in sectors which are less affected by the current cyclical downturn, [such as] French aerospace,” said Andrew Kenningham, chief Europe economist at Capital Economics.

So far Europe’s services sector has remained resilient; low unemployment and persistent wage growth across the region have kept domestic demand high, leading to the largest gap between manufacturing and services output since records began in 2006. That has kept the economic expansion going, albeit at a slower rate than previously forecast.

The main question for policymakers now is how long that can continue. Will manufacturing drag the rest of the economy down, or can it bounce back?

“German domestic demand is still holding up relatively well, but it is only a matter of time before the weakness in industry will also affect investment activity and private consumption,” said Katharina Utermöhl, senior economist for Europe at Allianz.

So the ECB is preparing to act. In the final months of his presidency Mr Draghi is laying the groundwork for fresh stimulus, possibly restarting the bond-buying programme which he closed at the end of last year just as the downturn in European industry was taking hold.

It is not clear how big a stimulus is needed, or whether it will prove effective; and the weakening global outlook is set to make it a hard slog. A Markit survey of automotive industry purchasing managers around the world fell to 47.7 in June, the lowest level since records began in 2009.

“Looming risks of a no-deal Brexit, US car tariffs and a non-negligible chance of a US-China trade war re-escalation should keep weighing on business sentiment and industrial activity in the second half of the year,” said Iaroslav Shelepko, an economist at Barclays.

As a result, many analysts remain gloomy about Europe’s economic prospects.

“We are not forecasting a recovery at this stage because we can’t see what would trigger a rebound in demand,” said Capital Economics’ Mr Kenningham.

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