5 minute read
2020 started off on a better footing for growth and data in Europe. Despite the recent coronavirus episode, and how it might unfold, we remain moderately optimistic for the economic outlook. Here’s why.
The situation in Europe pre-virus was improving markedly
Weak-ish GDP in 2019
Gross Domestic Product (GDP) growth for the fourth quarter of 2019 came out on the weak-ish side, up just 0.1% quarter on quarter, slightly under the consensus expectation of 0.2%. The weakness largely stemmed from the continuation of the de-stocking episode: domestic demand, and in particular private and public consumption, did well instead.
PMIs and business confidence are up in January
2020 started on a better footing, with January Purchasing Managers Index data (PMIs) up, and new orders/inventories ratios at stretched levels – implying pent-up demand. The composite PMI reached its highest level since last August, with manufacturing pointing to a rebound, and services robust and resilient.
Business confidence improved as well, at a 16-month high. The fact that the most forward-looking components of the PMI were particularly positive further suggests that the situation pre-virus was improving markedly, and that a significant acceleration was on the cards. Moreover, we continue to project a positive impact on 2020 growth from past monetary decisions and from the fiscal boost already in the pipeline for this year, as embedded in 2020 fiscal budgets
The composite PMI reached its highest level since last August, with manufacturing pointing to a rebound, and services robust and resilient.
A virus-free forecast for the rest of 2020
No material change to our euro area scenario, yet
Clearly, there is a risk that all the improvement seen in January might go into reverse, as the impact of the coronavirus episode spreads to exports to China, tourism, and global value chains… However, the tailwind was considerable and, if anything, we were considering revising up our forecasts before the outbreak.
It is important to remember that the impact of these outbreaks is generally short-lived and recovery likely, read our approach to assessing the market impact. Moreover, our China economist Peiqian Liu, expects only a marginal impact on China’s 2020 GDP growth – concentrated in Q1. This is largely thanks also to a reactive economic policy, of which we have already seen the first opening rounds.
Overall, our current assessment is that these forces largely cancel out as far as the euro area is concerned, and we have kept our expectations for a moderate 1% GDP growth this year unchanged, see our 2020 Year Ahead Outlook. On the inflation side, we have acknowledged the fall in oil prices recorded since mid-January, with however only a marginal impact on our forecast for the year: down to 1.2% from 1.3% previously.
If anything, we were considering revising up our euro area forecasts before the coronavirus outbreak.
Was the ECB turning less cautious before the virus scare materialised?
In an interview with the FT (dated 27 January), the European Central Bank’s (ECB) Chief Economist, Philip Lane, sounded somewhat more optimistic than in previous speeches and interventions from the ECB, we believe. He argued that wage inflation was now entrenched and that inflation in services was not dead, being in the high 1s. He also pointed out that he wouldn’t put all his probabilities on the narrative of ‘everything inevitably low for longer’.
However, in light of falling oil prices and concerns for the economy on the back of the coronavirus episode, our best expectation is that the ECB will tone the message down again. In a sense, it is already happening – on 5 February; Lane said that euro area inflation is still too low. Meanwhile, Christine Lagarde, President of the ECB, stressed that the coronavirus outbreak adds a new layer to economic uncertainty.
What does all this mean for markets?
Since the coronavirus outbreak, many market participants have sold down riskier assets and sought comfort in safe-havens such as developed market government bonds, especially German government bonds (bunds). This has since seen bunds rally, though markets have settled more recently – a pattern that is likely to repeat itself as stress over coronavirus ebbs and flows. Although bunds may appear attractive now, we’re still staying cautious in our outlook – a key theme we’ve been calling for a number of months now. As we saw in our Investor Survey, many investors are expecting too much pessimism for the European economy, and it is unwarranted in our view.