The credit impulse picked up very slightly in May 2019 in the euro area for households whereas it declined for non-financial corporations. The annual growth of loans to private non-financial sector stabilized at around 3.3%. Demand for credit is expected to rise in the third quarter of 2019 across all loan categories, stimulated by the easing of financing conditions, except for home loans, for which lending conditions are expected to tighten slightly.
The months pass but nothing seems to change. Growth in the manufacturing sector is struggling to accelerate in a persistently uncertain international environment, while buoyant domestic demand is boosting activity in services. The stronger-than-expected first quarter performance sends a more optimistic message than economic surveys. Faced with a downturn in inflation expectations and the downside risks to the Eurozone’s economic scenario, the European Central Bank (ECB) has been proactive again. It is prepared to ease monetary policy further and the new measures have been set up much earlier than expected. Yet faced with stubbornly mild inflation and only limited manoeuvring room, the ECB is bound to take a frugal approach.
Despite a quite good 1st quarter 2019 in terms of economic growth (+0.4% q/q), the latest economic indicators sent mixed signals. Worries about the Purchasing Managers’ Index (PMI) in the manufacturing sector remain despite its stabilization, at a low level, in June (47.8). In the services sector, the PMI seems to be unaffected by the manufacturing woes.
From 2008 to 2013, the eurozone experienced a sharp decline in investment. Despite a belated turnaround in 2014, total investment is still holding below its pre-crisis level. There are wide disparities between countries. After the crisis, the investment rate dropped off sharply in Spain, for example, but rose in France. The share of investment allocated to intangible assets, notably research and development, has increased to the detriment of tangible assets.
According to Mario Draghi, a key question is how long the rest of the economy can remain insulated from the weakness in the manufacturing sector. Historically, the purchasing manager indices for manufacturing and services have been highly correlated, which can be partly attributed to the important role of services in the value chain of the manufacturing sector. The future resilience of the services sector in the eurozone will very much depend on what happens in Germany where the gap between the PMIs of the two sectors is abnormally high.
The ECB has eased policy slightly, by extending its forward guidance on policy rates. On the other hand, the conditions on TLTRO III are slightly less generous than those on the previous operation. Importantly, a discussion has started within the Governing Council on how to react should the environment worsen. Understandably, given the eurozone fundamentals, the ECB is not yet in a hurry to react to the prolonged uncertainties. This is a matter of keeping its powder dry
After strengthening in February, credit impulse in the eurozone was relatively stable in March 2019 for households, but weakened slightly for non-financial companies. Demand for credit is expected to rise in the second quarter of 2019 across all loan categories. Although banks are planning to loosen conditions for consumer loans, they intend to tighten them slightly for home loans and business loans.
Survey data released this week provide mixed signals with an improvement of consumer confidence, a weakening of the ifo business climate index in Germany and a stabilisation of the INSEE indicator in France. The IHS Markit PMIs show a stabilisation in recent months in manufacturing, at a subdued to low level, and in services, at a more satisfactory level. Several drivers of domestic demand remain supportive. Nevertheless, unease remains, mainly for reasons on which the eurozone has no control and where the risk of further tariff increases is top of the list.
Most leading economic indicators are in line, or even above, expectations. Activity in the manufacturing sector remains subdued, the Purchasing Managers Index (PMI) reaching only 47.9 in April. This poor performance is partially offset by the resilience of the PMI Services Index which is below its long-term average but still well above the 50 threshold (52.8 in April).
The economic convergence of member states lies at the heart of thjavascript:void('Automatique')e initial project to create the eurozone, but it has followed a jagged path over the past twenty years. Convergence is a multifaceted concept that covers not only the criteria stipulated in the Maastricht Treaty but also growth dynamics and income dispersion. In the period before the Great Financial Crisis, nominal convergence was relatively complete, but progress towards real convergence was much more mixed. There are several major obstacles to a sustainable convergence within the European Monetary Union, including the lack of eurozone’s optimality, possibility of currency devaluations and macroeconomic stabilisation mechanisms.
The pass-through of wage growth to prices is stronger and faster when inflation is higher to start with. The low inflation in the Eurozone has slowed down the transmission. The considerable growth slowdown, on the back of adverse foreign demand and uncertainty shocks, impairs this process even more. This raises pressure on the ECB to take action in order to dislodge core inflation, which remains stuck well below its objective
The eurozone’s manufacturing sector has been hard hit by the decline in foreign trade and persistently high uncertainty. Very open internationally, the eurozone is sensitive to global cyclical slowdowns. Internal macroeconomic fundamentals are still solid, and the rally in the services sector is showing resilience. The ECB has taken note of the longer than expected slowdown, and has opted once again for longer-term refinancing operations (TLTRO). Numerous risks still cloud the forecast horizon, which could darken rather quickly if any of these risks were to materialise.
After contracting in January, the credit impulse picked up very slightly in February 2019. This trend is due almost exclusively to lending to non-financial companies, whereas the credit impulse has remained relatively flat for households since November 2018. Demand is expected to increase in second-quarter 2019 for all loan categories, stimulated by the easing of financing conditions, except for home loans, for which lending conditions are expected to tighten slightly.
After last week’s poor flash PMIs, data published this week show a mixed picture. The European Commission’s Economic Sentiment Index continues to decline in a large number of countries and for the eurozone as a whole as well. IFO data for Germany show an improvement in the overall climate though manufacturing continues to go down. INSEE data for France show a stabilisation or even some modest improvement. All in all there are some hopeful signs but it would be premature to conclude that the growth slowdown is about to end. April data will be particularly important.
The latest economic data are globally in line with, or even above, expectations. Some indicators remain at a high level compared to their long-term average. The further and significant deterioration in manufacturing activity draws our attention.
The ECB sharply lowered its 2019 growth forecast. Inflation is also expected to be milder over the entire forecast horizon. ECB president Mario Draghi noted that uncertainty was particularly high, but said that the vibrant labour market was supporting economic activity. Key rates would not be raised in 2019. Another round of targeted longer-term refinancing operations (TLTRO), with a maturity of 2 years each, would be launched starting in September 2019 and ending in March 2021.
In the eurozone, money market rates have been holding in negative territory for more than four years. The highest-rated government and corporate bonds are still yielding less than 1%. The distribution of interest rates around the zero lower bound was initially seen as an exceptional crisis adjustment mechanism, but the situation persists. Some expect this exceptional period to finally come to a close once the European Central Bank halts its net securities purchases and possibly begins to raise key rates after summer 2019. For others, the situation has definitively changed: a bit like Japan, the diminution of eurozone interest rates marks the erosion of growth potential and the quasi-elimination of inflation
During the last quarter of 2018, the annual growth of loans to private non-financial sector in the euro area stabilized at around 3.3%. However, survey data have showed a lower increase in the net demand of both households and enterprises since the beginning of 2018. Furthermore, and unlike in 2018, banks no longer plan to ease their conditions in 2019 Q1. In addition to the economic slowdown, these factors could weigh on the developments of loans outstanding in the euro area during the next quarters
The European Commission now expects 1.3% growth for the eurozone this year, down from 1.9% in its previous forecast. This downward adjustment doesn’t come as a surprise, considering the declining trend of several survey indicators. The recent performance of these indicators in tracking GDP growth is mixed, which makes the assessment of the current growth momentum challenging.
Most economic data remain low regarding their long-term average. Following three months of decline, the PMI services stabilized in January (51.2) and surprised on the upside. Economic growth in the Eurozone remained stable at 0.2% q/q in Q4 2018, reflecting divergent developments. In particular, Italy slipped into recession in late 2018 while French growth was resilient. Core inflation, still well below ECB’s medium-term inflation target, was above expectations.
After an eventful first twenty years, the eurozone is moving into a new phase of uncertainty. Growth has slowed markedly, and economic indicators have deteriorated. With temporary shocks and structural drags on growth, 2019 brings numerous risks. Against this background, and faced with underlying inflation that remains too low, the European Central Bank (ECB) is taking a cautious approach to this new year.