Economic Activity Outlook for the Euro Area - a Long and Winding Road Ahead

CEIC WorldTrend Data Talk - April 16, 2015 The past ten months brought a number of challenges and opportunities on both sides of the Atlantic: a record drop in global oil prices, the start of the euro area quantitative easing programme aimed at reviving its limping economic growth, and speculation that the US Federal Reserve will raise interest rates as it expects economic recovery to further tighten the labour market and stimulate inflation. These were some of the reasons for the plummeting bond yields in the Eurozone towards the end of 2014, and the depreciation of Euro against USD. The question is whether economic agents will react to these changes in a way that would increase activity in the Eurozone. While there is no doubt that lower fuel prices can reduce the production and service costs for businesses, historical review of the data shows that they have not been pivotal in the overall production and investment dynamics of the European Union (EU). From the historical trends of some key activity indicators, such as industrial production, investor confidence, and equity value, oil prices are a driver only in extreme circumstances when market participants are sensitive to any signal. For example, oil prices seem to have been one of the factors dampening investors’ expectations in the EU in April 2011, as measured by the Sentix economic indicator. However, this happened in the context of solvency issues in the Eurozone periphery and sovereign bonds yield curve reversal, oil price volatilities is just one of many factors contributing to the recession experienced by the euro area over that period. Indeed, European Central Bank’s (ECB) actions, as well as signals from the ‘real economy’, such as inflation and unemployment, consumer confidence, and domestic political crises seem to affect activity indicators to a greater extent. The key driver of reversing the trend of investors’ expectations and subsequently that of industrial production at the start of 2009 and 2012, and at the end of 2012 and 2014 seems to be ECB’s policy response to the euro area’s problems, conducted via large-scale monetary policy and liquidity stimulus measures. On the other hand, the main factors for turning the trends down for these indicators seem to be the negative signals coming from continuous disinflation, persistent shortage of demand and growing unemployment. For example, the announcement of the 3-year long-term refinancing operations (LTRO) in December 2011 led to the Sentix economic indicator rising 15.8 percentage points between January and March 2012, leading to stabilisation in the IPI. However, a sudden drop followed after poorer than expected data reported in March 2012 and the beginning of April (just before the Sentix survey was taken). February unemployment increased by 0.2 pp compared to December 2011, gross domestic product growth in the fourth quarter of 2011 slowed down from the previous quarter by 1.21 pp, wholesale and retail trade growth slowed down in January 2012 by 1.46 pp and inflation in February dropped slightly by 0.03 pp from December 2011 and was estimated to have dropped further in March. Focusing on a more recent time-span and considering the euro area equities as an activity indicator highlights the influences of political crises. After the ECB introduced the third round of the covered bonds purchase programme (CBPP3) on 20 October, 2014, the MSCI equity index picked up by 6.8% in a day. The positive trend continued after the Asset Backed Securities Purchase Programme (ABSPP) was announced on 21 November, until 27 November when the MSCI index dropped by 0.5% and continued on a downward trend until mid-December 2014. In this case disinflation and a stagnant labour market, plus what was considered insufficient activity in bond holdings under the ABSPP, were influential. However, there was also another factor, a political one. The Greek bail-out question arose, which was to shape market reactions even further after 29 December 2014 when the Greek parliament dissolved. The negative trend turned around for a longer period only after 7 January 2015 when new CPI data was released for December 2014 by Eurostat. Although the rate of inflation was negative, it was considered as a consequence of falling oil prices, rather than the weak economy. Moreover, the data was taken as a signal that the ECB would roll out a new money supply expansion programme, purchasing government bonds. Equity markets reacted anticipating of euro currency depreciation, falling bond yields and increased equity trading. Investor, business and consumer sentiment also forecast increased economic activity, thus upward revisions of the official IMF World Economic Outlooks forecasts, to be released on April 14 is expected. Final inflation and unemployment figures for the first quarter are showing improving trends (reaching -0.9% annual growth and 11.9% rate, respectively), so their development in the next few months will be keenly monitored. By Hristo Nikodimov - CEIC Analyst Discuss this post and many other topics in our LinkedIn Group (you must be a LinkedIn member to participate). Request a Free Trial Subscription. Back to Blog
16th April 2015 Economic Activity Outlook for the Euro Area - a Long and Winding Road Ahead