The recent weakness in the euro area economy has come as a surprise to many. Is it a result of a series of one-off factors, or is there something perhaps more persistent?
Growth in the eurozone was 1.2% YoY in Q4 2018, down from a cyclical high of 2.8% in mid-2017. If we look at it in quarterly growth terms, it was 0.2% in Q3 and Q4, half what it was in Q1 and Q2.
Our analysis suggests that a combination of temporary and lasting factors are responsible. The former include poor weather, distortion in the German auto industry and the economic repercussions of the ‘gilets jaunes’ protests in France. The latter incorporates overall slower global growth and tighter financial conditions.
A grey winter for Germany
The German economy narrowly avoided a technical recession in late 2018 with GDP virtually flat in Q4 2018 after a 0.2% contraction in Q3.
In our view, several factors caused Germany’s lacklustre performance. Firstly, its economy experienced a cyclical slowdown after exceptionally strong growth in 2017. In addition, industrial production was hit hard by the roll out of new EU emission vehicle standards in September, as well as disruptions to the pharmaceutical industries from low levels of water in the Rhine. As a large exporting country (exports are around 50% of GDP), rising global trade tensions have also hurt Germany particularly hard. Separately, private consumption growth was surprisingly tepid.
Any structural slowdown here would likely limit growth across the rest of the region, and 2019 looks to have started as 2018 ended. However, while the risks loom large, chances are that a brighter spring could still follow the grey winter if trade tensions do not escalate badly, China escapes a hard landing, and the UK avoids a hard Brexit.
Domestic demand and fiscal policy need to pick up the slack
While the more export-led and manufacturing-based economies of Germany and Italy are underperforming, the domestic demand and services sector-driven economies of France and Spain are holding up better.
Households can pick up some of the slack. Consumer confidence, as measured by the DG ECFIN, increased for the second month in a row in February. This level of confidence should imply consumer spending at a solid 2% annual pace, and with inflation heading down thanks to lower oil prices and improved labour market prospects, consumers should have more disposable income.
Fiscal policy is also turning more expansionary this year, with government measures to boost income for households, particularly for low wage earners in France and Spain. This could increase area-wide growth by 0.2-0.4pp.
What does this mean for investors?
Low growth in the eurozone is likely to have an impact on both currency valuations and company revenues. It is therefore important to seek out investment opportunities that are exposed to long-term growth trends rather than areas of cyclical weakness.
Our thematic investment process is one way to identify such companies. For example, Erste Bank is part of our Evolving Consumption theme. There is currently low credit penetration in Eastern Europe, where Erste is one of the largest players, and as incomes rise, consumers will require increasingly sophisticated financial products. It should therefore experience growth for many years to come and be largely insulated from any slowdown in the core euro area.