Economy and inflation

Eurozone out of recession in Q3. According to a flash estimate of Eurostat, the Eurozone GDP increased by 0.4% q/q in the third quarter. There are no detailed results available yet, the components will only be published on 3 December. However, we expect economic stimulus packages (such as the car scrappage premium) and positive effects from the inventory adjustment cycle to have contributed significantly to this positive development.

GDP forecasts slightly revised. But since GDP growth was slightly below our expectations in Q3, the supporting effect from the inventory depletion cycle seems to have been less significant than envisaged. In fact, we now assume that this process (end of inventory depletion inventory building) is progressing more slowly, but that it might therefore support the GDP right into the first half of 2010. We therefore revised our GDP forecasts for 2009 from -3.7% to -3.9% and for 2010 from +0.5% to 0.7%.

Private consumption no growth driver. After the expiry of the stimulation measures (e.g. the car scrappage premium) it remains to be seen how robust consumer demand will be. The rising unemployment rate will undoubtedly burden the propensity to consume next year. While higher nominal wages will offset inflation, they will fail to take any clearly positive effect on purchase power. This means that we do not expect any growth stimuli from the private consumption front in 2010.

External demand may be good for a surprise or two. The historic pattern would suggest that the first stimulus for an economic recovery of the Eurozone should be coming from exports. In the event, production figures should rise and, given the higher utilisation of capacities, would trigger stimuli for investments. The creation of jobs would support private consumption.

Eurozone foreign trade accounts almost in balance. The entire currency region is reasonably balanced, but some countries (e.g. Germany) are net exporters and thus more affected by the slump in global demand. But the entire Eurozone relies heavily on exports in terms of economic stimulus - in spite of the even trade balance. One has to bear in mind that in addition to the direct growth contribution of net exports (= exports - imports), numerous supplier sectors of exporters benefit from external demand. For example, machinery manufacturers or car part suppliers for car manufacturers that sell abroad may provide an additional growth contribution. It is therefore important not only to monitor the development of net external demand, but also export dynamics. The change in exports is a good indicator for the development of the industrial production of export-oriented countries. The following chart shows impressively the match of export dynamics and industrial production for Germany.

Germany: exports and industrial production


This relation also goes a long way explaining why the economic dynamics of the Eurozone are influenced by the US. Sharply rising exports to the US come with a multiplying effect on economic growth, possibly with a time lag due to delivery periods etc. Apparently there are also a number of other important factors, such as for example the transfer of sentiment, which is why the US economy is leading the economic cycle of the Eurozone. According to a monthly report by the ECB, US declines would reach the Eurozone with an average time lag of two quarters, whereas upswings would usually happen with a time lag of six quarters. Given that we expect only low growth rates for the US next year, this will probably also find itself reflected in the economy of the Eurozone.

US has a small share in Eurozone exports. A glance at not only growth dynamics but also the share of Eurozone exports to the US in terms of total exports shows that the US accounts for only a small share. The overwhelming majority (about 50%) is exported within the Eurozone, and is therefore of no interest as external growth driver. European countries outside the Eurozone account for another 25% of exports; Asia ranks third, followed by the US. Could this region spawn additional growth in the future?

Eurozone: exports, nominal, by the five most important destinations, nsa


2010 only moderate export growth. There will probably not be any additional external demand from European countries to further stimulate growth for the time being, with Great Britain and Russia particularly severely affected by the crisis. Export growth to Asia, on the other hand, is currently round about zero (after a substantial slump in January 2009, exports have remained stable), but might generate positive dynamics in the future. There is certainly some potential in this scenario. However, we still do not expect the Asian markets to fill the gap in demand growth caused by the American or European regions in the short run. We envisage moderate export growth from low levels in 2010.

Investment remains weak. Recovering exports should contribute positively to GDP growth in 2010, but industrial production will probably not grow at sufficiently high rates for average utilisation rates to be reached. This means that the corporate sector continues to lack an important requirement for capital expenditures in tangible fixed assets in the coming year. Therefore we do not expect any sizeable degree of support from the trusted growth drivers exports and investments in 2010.

Inflation low in the foreseeable future. Consumer prices have rebounded from their lows in the third quarter and settled at close to zero in October. Due to the still low capacity utilisation and the sharp decline in producer prices, there is no upward pressure on prices that could be passed on to the consumers, especially in view of the weak private consumption. Only base effects in energy and food prices will take monthly inflation into positive territory towards the end of the year. We expect an average rate of inflation of +0.3% for the full year of 2009.

Eurozone inflation vs. core inflation y/y (%)



Monetary policy

ECB warnings over high debt. President Trichet has not presented any changes to the economic assessment in his recent statements. He was pleased about the fact that the inflation expectations had been anchored and that deflation had been avoided. He was unusually outspoken with regard to public debt, since the high (and rising) level in many member states required clear strategies for consolidation. Otherwise a lack of trust might quickly change the market sentiment. As a result, medium and long-term financing costs could take a turn for the worse (with negative implications for private financing). The ECB is closely monitoring whether the markets continue to require liquidity support to the same extent and will ensure that the liquidity is withdrawn at adequate rates and with appropriate timing if need be. We think that the next 12M repo auction in December will be offered at a small premium on the key lending rate. The key lending rate itself should remain at 1% until well into 2010, as pointed out in our economic and inflation forecast.

ECB key lending rate vs. 3M Euribor (%), spread (bps)


Bond market

No increases expected on the bond market. Volatile economic data show that the recovery of the economy is not yet a robust one. Investors still seem to find the bond market attractive as far as the risk profile goes. In fact, investor demand at the short end picked up at the beginning of November, and 2Y yields were falling continuously below 1.2% before rebounding and staying above 1.3%. We think that 2Y yields will increase only slowly in the coming months, given that we should see initial interest rate hikes only in 2010. 10Y yields of German government bonds should edge slightly higher in the coming months, which is why the interest rate curve should remain steep at 200bps for a while. In the short run, the bond market should move mostly sideways. In 2010 we expect both the short and the long end to correct, resulting in rising yields.

10Y-2Y German government yields, spread (%)