Thomas White Global Investing
Developed Europe: July 2017

Developed Europe

Economy Trends Update July 2017

 

AT A GLANCE

 

Germany: German GDP climbed 0.6% between the first quarter and the second, recording its 12th consecutive quarter of growth. Private consumption jumped 0.8% while construction investment surged 0.9%.

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The U.K.:Britain’s GDP edged up 0.3% in the second quarter, which is only a shade faster than the 0.2% growth achieved in the previous quarter. Other data reinforced concerns that Brexit-related uncertainties are taking a toll on the economy.

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France: The French economy expanded 0.5% from April to June, recording its fourth consecutive quarter of growth, which is most likely a sign that the economy is finally on a rebound after years of inconsistent progress.

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Italy: From April to June, Italy’s GDP expanded 0.4% quarter-on-quarter, its tenth consecutive quarter of growth. Also, year-on-year, GDP increased 1.5%, which marked Italy’s best annual growth rate since 2011.

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Spain:  Spain’s GDP jumped 0.9% in the second quarter, recording its fastest pace of expansion in two years. Between the first quarter and the second, the country’s unemployment rate fell from 18.8% to 17.2%, its lowest level in eight years.

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Outlook brightens; recovery stronger and broad-based

The newfound optimism around Developed Europe grew unabated during the May-July review period. GDP in the largest and the most significant part of the region, the single-currency Euro-zone, expanded 0.6% in the second quarter, meeting estimates but outpacing the 0.5% growth clocked in the first quarter. On an annual basis, seasonally adjusted output surged 2.2% at the end of June, outperforming the 1.9% growth achieved in the first quarter.

The individual GDP data from most of the 19 member-countries in the Euro-zone underscored the broad-based nature of the recovery underway in the region. Among the larger economies, Germany and Spain continued to lead the pack of outperformers while France signaled that its economy was finally on a sustainable rebound. Italy shed its ‘laggard’ tag to post encouraging growth figures. Several smaller economies in the Euro-zone, including the Netherlands, expanded faster than expected. Besides GDP data, other indictors tracked during the second quarter, such as economic sentiment, the unemployment rate and manufacturing output, also pointed to the robust health of the Euro-zone economy.

For the current and future quarters too, the outlook for the Euro-zone looks bright. According to Bloomberg, a measure of economic sentiment reached its highest level in a decade at the end of July. Further, a recent European Commission report says that “manufacturers are working at a higher capacity” and price expectations have risen in all sectors. Even European Central Bank (ECB) President Mario Draghi has expressed confidence that the Euro-zone recovery is likely to strengthen in the second half of 2017 and trigger a sustained pickup in inflation. Notably, the ECB is waiting for cues from inflation figures to start planning the gradual withdrawal of its quantitative easing or bond-buying program. At the end of July, the Euro-zone’s annual inflation stood at 1.3%, a level that is currently below the ECB’s target inflation of “less than, but close to, 2%.”

 

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Germany: Strong consumption, public spending sustain upswing

Germany’s upswing continued during the latest review period. The country’s seasonally adjusted GDP climbed 0.6% between the first quarter and the second, recording its 12th consecutive quarter of growth. On an annual basis, output expanded 2.1% at the end of June, which is slightly higher than the 2% year-on-year growth achieved in the first quarter. The second-quarter performance was chiefly driven by strong consumer and government spending.

Buoyed by rising wages, a robust employment outlook and low interest rates, private consumption jumped 0.8% in the second quarter, while Berlin’s mounting expenditure to accommodate the nearly one million refugees who have arrived in Germany since the beginning of 2015 boosted construction investment 0.9%. In fact, strong domestic demand pushed up imports as much as 1.7% during the second quarter whereas exports managed to grow only 0.7% in the same period. So, ironically for export powerhouse Germany, net trade had a negative impact on second quarter growth.

Notably, Germany’s current economic strength is a source of great optimism not just for the wider Euro-zone economy but also for Chancellor Angela Merkel. General elections are slated to be held in the country in the last week of September and Chancellor Merkel is seeking a fourth term in office. So, the recent positive data will most likely boost her economic credentials before the polls. 

Irrespective of how the elections will shape Germany’s political landscape, the country’s economy appears well-placed to sustain its momentum. Business confidence among German manufacturers remains strong as they continue to invest in labor and equipment to fulfill new orders. Incidentally, new orders in the manufacturing sector increased twice as much as expected in June. The construction sector should also stay buoyant on the back of government spending on refugee rehabilitation. In the first half of 2017, construction companies saw orders growing 5.5% from the same period last year, which augurs well for business in the coming months.

 

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The U.K.: Economy stays subdued as Brexit uncertainty lingers

Most of the data Britain reported during the May-July review period reinforce concerns that Brexit-related uncertainties are taking a toll on the economy. GDP in the country edged up 0.3% in the second quarter, which is only a shade faster than the 0.2% growth achieved in the previous quarter. More importantly though, the latest GDP growth rate is significantly weaker than the U.K.’s average growth rate over the past few years.

Also, worryingly, household spending merely inched up 0.1% from April to June, clocking its weakest pace of increase since 2014. Further, according to Bloomberg, investment remained subdued all through the second quarter. In fact, during this period the only bright spot in the economy was the services sector, which recovered following a brief slowdown in the first quarter. The sector expanded at its fastest pace in 10 months at the end of June.

Nevertheless, it appears that the outlook for the British economy is likely to remain subdued in the coming months too. According to the National Institute of Economic and Social Research, services sector activity softened again in the beginning of the third quarter. Further, the pound’s weakness since the Brexit vote has pushed up inflation, which is likely to continue hurting household spending. Annual inflation stood at 2.6% in July, having risen from 1.8% at the start of the year. The Brexit impact on investment decisions is also expected to linger as businesses wait for clarity on the kind of deal Britain will strike with the European Union.

 

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France: Well-placed for Macron’s reforms

The French economy expanded 0.5% from April to June. In fact, according to national statistics bureau Insee, GDP grew 1.4% during the first half of 2017, which is as much as the European Commission had forecast for the entire year. Both investments and exports advanced in the first quarter, with net trade comprising the largest contribution to GDP for the first time in more than seven years. Notably, France has now recorded its fourth consecutive quarter of growth, which is most likely a sign that the economy is finally on a rebound after years of inconsistent progress.

Indeed, with political stability returning to the country following the presidential election in May and tax cuts by the previous administration beginning to take hold, a record level of consumer confidence was observed in July. The same month saw business confidence soar to its strongest level since 2011. What’s more, Insee’s production outlook indicator climbed to its highest level since 2001. The strength of these confidence indicators reflects the optimism around new President Emmanuel Macron’s reforms agenda.

President Macron has promised to implement the first phase of his labor-market reforms by the third week of September. This set of reforms is expected to focus on providing businesses with a greater say in fixing working hours and wages as well as putting a ceiling on severance pay. The Macron administration also plans to reduce taxes, slash public spending by 20 billion euros next year and cut the budget deficit to below 3% of GDP.

 

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Italy: Economy shrugs off bad-loan problems, marches ahead

After many quarters of lackluster performance, Italy finally mustered a set of encouraging economic data during the May-July review period. From April to June, the Euro-zone’s third largest economy expanded 0.4% quarter-on-quarter, its tenth consecutive quarter of growth. Notably, this pace of expansion was slower than the Euro-zone average of 0.6%, but several other indicators pointed to a strengthening momentum in Italy’s recovery.

For instance, year-on-year, GDP increased 1.5% at the end of June, which marked Italy’s best annual growth rate since 2011. What’s more, both the services sector and industrial output registered robust growth between April and June while exports improved despite a stronger euro. Also, the country’s unemployment rate remained in a downtrend all through the second quarter, falling to 11.1% in June from 11.3% in May and 11.8% in January. Italy appears placed to do well in the third quarter too. The PMI for the country’s services sector recently reached its highest level in 10 years. In fact, with all these positive developments, the International Monetary Fund (IMF) has upgraded its 2017 growth forecast for Italy.

Nevertheless, on a cautionary note, the country is not without short-term risks. The Italian banking sector remains beset with bad loans worth about $350 billion, which is not just crimping bank profitability but also hurting lending in the economy. Further, consumer confidence is still subdued in the country, given that wages have hardly improved since the financial crisis.

 

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Spain: Outlook improves as recovery momentum gains strength

In line with the trend over the past few years, Spain reported yet another round of impressive data during the May-July review period. The country’s GDP jumped 0.9% in the second quarter, recording its fastest pace of expansion in two years. On an annualized basis, output increased 3.1%. Official statistics reveal that strong exports and tourism sector activity played a key role in the second-quarter performance. Exports climbed 10% in the first half of 2017 and the number of foreign tourist arrivals in Spain surged 12% during the same period. What’s more, household expenditure growth nearly doubled to 0.7% from April to June.

This is a significant development because at the start of the year, economists had projected a gradual moderation in household spending due to stronger inflation and a rise in energy costs. But apparently, recent labor-market improvements helped Spaniards shrug off the impact of higher prices. Speaking of the labor market, between the first quarter and the second, Spain’s unemployment rate fell from 18.8% to 17.2%, its lowest level in eight years.

Not surprisingly, given these indicators, the 2017 growth estimates for Spain have been upgraded by both the government and the IMF. In fact, describing Spain’s recovery as “impressive,” the IMF recently upgraded its forecast (from 2.6% to 3.1%) for the second time in seven months. Further, assuming Spain’s continued recovery and budget consolidation, both S&P Global Ratings and Fitch have revised their outlook for the country’s credit rating from ‘stable’ to ‘positive.’

 

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