Euro Economic Bulletin, 9 September
Germany: Economic upswing in July
Industrial production rose for the third month in four in July, posting a 1.8% rise in 3-month average terms, its biggest increase since the beginning of the year. Meanwhile, manufacturing orders recorded their fourth increase in five month, surging by 3.7%, their biggest increase since the beginning of the year. It sounds like the confirmation that the expected upswing in activity is currently occurring.
Actually, manufacturing orders rose thanks to a sharp increase in foreign orders (+7.7% m/m). In particular, foreign orders for machinery and equipment jumped by 10.1% m/m, posting their third straight increase, like those for intermediate goods (+5.9%). These results confirm that exports remain a strong engine of growth in Germany.
The matter comes from domestic orders, which slightly declined in July (-0.1% m/m). Admittedly, they had risen the previous two months, but their July decrease raises concerns about the recovery of the domestic demand. In Q2, the latter stagnated as the rise in public consumption and business spending was offset by a further contraction of private consumption.
In July, domestic orders for capital goods fell by a large 4.1% m/m. However, this drop looks more like a correction of June 7.7% rebound and does not indicate that firm are cutting their investments in Q3. Actually, thanks to supportive exports, business spending is expected to keep on growing, in line with the improvement in leading indicators since June. This outlook seems confirmed by the 0.8% m/m increase in production for capital goods in July.
Besides, after two quarters of contraction, household spending is expected to pickup in Q3. This is probably what firms expect, as they increased their orders for consumer goods by 4.2% m/m in July, their biggest increase in five and a half years.
Nevertheless, the rebound in private consumption will remain erratic and fragile. Admittedly, unemployment has declined since April and consumer confidence started to pickup according to the GfK Institute Survey. Nevertheless, the labour market situation hardly improved and oil prices continued to increase. Therefore household could remain cautious in the coming months.
Italy: Whereas business confidence rose further in August (index up at 87.5), consumer confidence is still lagging behind (index down at 100.8)
Business confidence increased further in August, going up to 87.5, from 86.4 in July, reaching its highest level since last January.
The improvement of business confidence can be explained by the catching up in the assessment of total orders, both from the domestic or the foreign market. Besides, expectations of production rose markedly (from –16 in July to –10 in August).
The rise in business confidence occurred in all sectors, especially in intermediate goods (84.1 in August versus 82 in July) and in investment goods (from 88.3 in July to 89.5 in August). Moreover, the same goes with consumer goods but to a lower extent (from 90.9 in July to 91.2 in August).
This survey contrasts with that on consumer confidence released yesterday in August. Consumer confidence index dropped once again, although slightly down to 100.8 from 100.9 in July for the fifth consecutive month. The main concern for Italian households is their current and expected personal situation. Indeed, the assessment of personal economic situation has worsened markedly (from 114.4 to 112.2).
On balance, prospects about Italian economic situation are still uncertain. Higher oil prices, if they have already affected household confidence, haven’t yet hampered business confidence. Yet, OECD revised upward growth expectations for 2005 at 0.2%, but economic activity remains fragile.
- Business confidence rose in August
For the third month running, business confidence rose in August. The ISAE confidence index, based on a survey among 4,000 manufacturers carried out between August 1st and August 26th, enhanced from 86.0 in July to 87.5, its highest level since last January. This rise is in line with other European surveys (IFO in Germany) procuring little hope for improvement soon.
- A general improvement
The improvement of business confidence can be explained by the catching up in the assessment of total orders, both from the domestic or the foreign market. Besides, expectations of production rose markedly (from –16 in July to –10 in August). The euro’s 8 %-decline against the dollar this year favoured Italian products making them cheaper and offsetting high oil prices. The rise in business confidence was visible in all sectors, especially in intermediate goods (84.1 in August versus 82 in July) and in investment goods (from 88.3 in July to 89.5 in August). Moreover the same goes with consumer goods but to a lower extent (from 90.9 in July to 91.2 in August).
- By contrast, pessimism of Italian households
This survey contrasts with that of consumer confidence released yesterday. In August, the consumer confidence index, based on a poll of 2000 households by the Rome-based ISAE Institute carried out between August 1st and August, 12th, dropped once again, although slightly down to 100.8 from 100.9 in July, for the fifth consecutive month. The main concern for Italian households is their current and expected personal situation. Indeed, the assessment of personal economic situation has worsened markedly (from 114.4 to 112.2). Thus, higher oil prices weighed on both Italian household confidence and their assessment on their current and expected savings, but they are more and more optimistic about the medium-term national economic situation.
- To the beginning of a real rebound
On balance, prospects about Italian economic situation are still uncertain. Higher oil prices, if they have already affected household confidence, haven’t yet hampered business confidence. Indeed, expectations of Italian companies for next three months are good as regards employment (from –7 in July to –2 in August) and the level of production (from 11 in July to 12 in August). Yet, OECD revised upward growth expectations for 2005 at 0.2%, but economic activity remains fragile.
United Kingdom: As expected, the Bank of England keeps its repo rate at 4.5%
As expected, the Bank of England's Monetary Policy Committee has decided to keep its repo rate at 4.5%.
Given the uncertainties, domestic as well as international, rates are expected to remain on hold in the coming months.
A further rate cut should not be excluded if economic growth is losing momentum as a result of higher energy prices and the cooling down of the housing market.
At the end of its two-day meeting, the Bank of England's Monetary Policy Committee decided to keep the repo rate at 4.5% As usual, the Bank did not release a press statement, and we have to wait for the publication of the Minutes on 21 September to know exactly the reasons for the decision. However, as the decision was widely anticipated, the reasons are not difficult to guess.
The latest data show that the economy is picking up after hitting a trough in Q2. This is in line with the Bank's growth scenario. Moreover, inflation has surprised on the upside. In July, it reached 2.3%, an eight-year high. This is partly due to temporary factors, such as the hike in energy prices. More worrying is the impression that the forces that kept inflation down in the past, are gradually fading. In particular, the weak retail sales have not been translated into heavy discounting. The news coming from the housing market is also not quite reassuring for the Bank.
The growth in household borrowing, although easing, remains very high. In July, net lending to individuals rose by 10.7 % y/y. The RICS reported in its latest survey that house prices were falling in July at the slowest pace in five months. The mood in the housing market was probably bolstered by the expectation of an August rate cut (now confirmed). Yesterday, the Halifax reported that house prices gained 1.6% in August (2.6% on an annual basis), the fastest increase since September 2004. However, this is likely a statistical blip. As the ratio of house prices to average earnings is relatively high, we do not expect house prices to surge again. The impact of the housing market on private consumption is very difficult to assess, and is likely to be underestimated by the Bank. International economic developments are dominated by the renewed hike in oil prices caused by Hurricane Katrina. However, it is still to early to gauge its full impact on the global economy.
Given these uncertainties, the MPC took the right decision to put interest rates on hold. In the August Minutes it signalled to the financial market, that further rate cuts should not be expected. This stands in sharp contrast to the opinion of OECD chief economist Jean-Philippe Cotis, who argued that the Bank of England could lower rates as long as inflationary expectations remain well anchored. We share his opinion. The Bank of England might overestimate the growth momentum in the economy. In the coming months, more evidence is likely to surface that the economy is slowing under the impact of higher energy prices and the cooling-off of the housing market. This could necessitate a further cut in the repo rate.
Write: by Luis Batista, September 2005