 | Still stuck in a deepening downturn: Donald Trump’s trade wars, the slowdown in China, the Brexit mess and structural problems in the car industry are taking a heavy toll on the Eurozone economy. While consumer confidence and spending are holding up well, manufacturing is descending ever more deeply into recession. Even worse, the manufacturing downturn is spreading gradually to parts of the service sector. Whereas the purchasing managers’ index for manufacturing fell to an 83-month low of 45.6 in September according to Markit, the index for services also softened to 52.0. The data suit our assessment that Eurozone growth has slowed to a pace of 0.1% qoq in Q3. Further drops in the inflow of new orders signal a clear risk that Q4 could be even weaker. |
| Money matters: In the bank-based financial system of the Eurozone, major and sustained changes in monetary dynamics usually herald cyclical turning points some three quarters in advance. Supported by ultra-loose monetary policies, the growth in real M1 money supply accelerated to 8.4% yoy in August. Taking the July and August data as a proxy for Q3, the resulting increase in real M1 suggests that GDP growth could regain momentum shortly (see chart). |
| Not a perfect fit: Money supply does not drive GDP growth directly. Financial crises and external shocks can weaken the link between money and actual spending. If companies and households are unusually scared, they hold back the cash by more and/or for longer than usual. As a result, our forecast for real GDP growth is well below the pace that the turnaround in real M1 might suggest. |
| Room for a rebound: Nonetheless, the acceleration in Eurozone M1 carries a message: egged on by the ECB, households and non-financial corporations are rapidly building up liquid balances. For now, they are more likely to treat these pre-cautionary balances as buffers against a worsening economic outlook instead of spending the cash soon. But if and when the fear factor fades, they would have the money to step up their spending nicely. |
| Coping with shocks: For our base case, we assume that the US-Chinese trade war will not escalate much further beyond the tit-for-tat threats that both sides have made so far. Also, China looks likely to beef up its domestic stimulus by enough to prevent a worsening domestic calamity. Although Brexit is a mess, the risk of a disruptive hard Brexit does not exceed 35%, in our view. If none of the external shocks hitting global manufacturing and trade gets much worse than it is already, households and companies are likely to get used to the noise and risks over time. As a result, we look for the downturn in European – and global – manufacturing to bottom out in early 2020. A potential US-Chinese trade deal and a Brexit resolution that avoids a hard Brexit could turn the ensuing gradual rebound into a stronger recovery. Money supply shows that households and companies in the Eurozone would have the means to raise their spending significantly if and when they feel confident enough to do so again. |
Holger Schmieding
Chief Economist
+44 20 3207 7889
holger. schmieding@ berenberg. com
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