ECONOMETER

There have been two pieces of data released over recent days which give us a good idea of the state of Europe’s biggest economy, Germany. The IFO survey – a crucial gauge of business confidence and an important forward looking indicator for the German economy, if not the whole eurozone economy – increased in May for the second straight month but came in lower than forecast. The second was the final reading of first quarter GDP, which confirmed the very steep 3.8% quarterly decline in growth, fuelled in large part by weaker exports.

Of course any improvement is encouraging but the fact that the rise in the IFO was less than expected highlights that the market has moved from excessive pessimism to being overly optimistic about recovery prospects. Moreover, at current levels the IFO remains at historically lows and still consistent with economic contraction. Admittedly it is at least consistent with a smaller pace of contraction in the economy in the months ahead but still way off indicating actual economic expansion.

The problem for Germany as highlighted by the GDP data is that the economy remains highly export dependent and given that global trade continues to shrink it points to very difficult times ahead. Moreover, the likelihood of a much bigger increase in unemployment and ongoing problems in the financial sector, points to the outlook for the consumer remaining very tough indeed for a long time to come.

Financial sector problems will only delay recovery.  A report in the UK’s Telegraph even carries a warning from the German bank regulator that toxic debts at German banks could blow up “like a grenade”. I won’t spend any more time on toxic debts at European banks but suggest reading a previous post titled “Stress testing European and UK banks” ,that highlights the lack of transparency and potential for much more writedowns in the months to come.

The problem is not just a German one. The eurozone economy is likely to recover much more slowly than the US despite the fact that the US was at the epicenter of the crisis. The major difference is that policy in the US is far more aggressive and rapid compared to Europe. European policymakers have struggled to put together any form of co-ordinated policy response and there is still an unwillingness from Germany to enact a fiscal stimulus package despite the fact the economy has weakened more rapidly than many other countries.

Moreover, conflict within the European Central Bank (ECB) council means that an aggressive move towards quantitative easing appears highly unlikely. The latest measure by the ECB to purchase EUR 60 billion in covered bonds hardly registered with markets. Faced with many opposing views from within the ECB representing many different countries this situation is unlikely to change anytime soon. As a result, Europe is destined for a snail’s pace of recovery, which could also stall the appreciation of the euro in the month ahead.