Erik Nielsen On Europe Past And (Immediate And Rosy) Future
Goldman's Erik Nielsen has yet to disclose if he is joining his Euro-pal Jim O'Neill in declaring all out war on the bears (for those unsure about the reference see here, and FYI Jim, the grizzlies send their love... and in keeping with the animal references, they don't really give a rats ass about the occasional dead cat bounce). What he has no problem disclosing, however, is his latest round of rose-colored ebullience, even as other, "slightly" more objective europundits see the end of the Eurozone as ever more imminent. It is stunning how cognitive dissonance can lead two people to the following diametrically opposite conclusions: Erik Nielsen: "The European recovery continues to look pretty good and solid to me" and Ambrose Evans-Pritchard: "[the Pan-European austerity package] can end only in two ways. Either Germany tolerates massive monetary reflation by the ECB or Spain will be forced out of EMU, setting off a catastrophic chain-reaction through north Europe's banking system." Of course, when one is in the business of perpetuating ponzies, while another has a page view quota, the truth likely is somewhere inbetween. Then again, "inbetween" two polar opposites is a wide range. Anyway, since we will likely see a lot more pain "on the plain" shortly, here are some soothing words for all those who are still long and strong and need goal-seeked analyses.
Happy Friday night,
Gosh, I can’t believe I just wrote that, but here I am collecting my thoughts on Europe while others are out having fun. But I’ll be off to my local coast in Denmark tomorrow morning for a long weekend - and writing this now seems a better idea than spoiling the (almost) midsummer nights up on my childhood beach. Here goes:
- The past week delivered another stream of good, to very good, real economy data out of Europe while markets started to calm down the last couple of days.
- We also saw a number of important policy measures in Spain and Italy.
- Fitch downgraded Spain today, but I really can’t get excited. AA+ is fine, but the timing… Some thoughts on why I differ from a lot of people on the prospects for the Euro-zone.
- Former PM and finance minister, and present head of the IMF’s European department, Marek Belka is about to be named the next governor of the Polish central bank; great news.
- Next week in the Euro-zone will be dominated by Wednesday’s FX-auction at the ECB. A big demand could re-start a degree of market volatility.
- PMI-week is coming up in the UK; we’ll probably see a levelling off this high level like everywhere else.
- Switzerland is set to print Q1 GDP and their PMI. We expect a strong GDP number (+0.8% qoq, non-annualised) and a flattening of the PMI.
- Sweden will release the two key private-sector business surveys next week; we expect the KI/NIER to push higher, and the PMI to give back a tad.
- Norway is set to publish retail sales and their PMI; we expect strong retail numbers and a small decline in the PMI.
1. In the battle between the recovery in the real economy and the stress in the financial sector the former is now one set up. Last week saw further signs of pretty good growth throughout Europe: Euro-zone confidence indices were stable at good levels (with the exception of French consumers) and Eurocoin pointed to 0.55%qoq (non-annualised) GDP growth in the Euro-zone in May. Earlier today Switzerland reported very strong export growth in May (+3%mom), suggesting solid demand in their biggest market, the Euro-zone, and Sweden reported a blockbuster Q1 GDP growth of +1.4%qoq (non-annualised) and – in line with our general view that in Europe the PMIs and better indicators of GDP than the first prints – Swedish 2009’Q4 GDP was revised to +0.4%qoq from -0.6% … that’s right; a full one percent qoq better than first reported! Sweden benefits from exports of investment goods, not unlike Germany; and earlier this week we learned that the strong German export numbers for April was driven by good demand from all markets (apart from India), with – guess who – China taking the biggest increase (14%mom). God bless the Chinese! The European recovery continues to look pretty good and solid to me. After doing its best to spoil the party early in the week, markets starting to cave to the reality of the real world the last couple of days of the week.
2. Meanwhile, progress continued on the policy front. Italy announced a sizable EUR24bn in budget cuts, mostly on the spending side, for 2011-2012, which should bring the deficit down to 2.7% of GDP in 2012, and Spain passed its package to cut the deficit to 6% of GDP next year (from 11.2% in 2009), including via a 5% wage cut among civil servants – although with just one vote after the Basque nationalists decided to vote against the package. (See our European Views earlier today for an overview of the measures throughout Europe and their likely impact on growth.) Equally important, last weekend’s take over of Cajasur seems to have been the opening shot in the (long overdue) acceleration of the bank clean-up in Spain. Yesterday, the Bank of Spain proposed a number of stricter provision requirements; this is important stuff because it’ll eventually bring clarity to the hole in their banking system. As Javier Perez de Azpillaga argued in his European Views earlier this week, we think the hole is perfectly manageable and extremely unlikely to amount to more than 10% of GDP.
3. Fitch downgraded Spain to AA+ from AAA earlier today; maybe they got inspired by the FT’s Lex column… On a more serious note, it didn’t surprise me, and it doesn’t bother me the slightest. With all due respect, the ratings agencies have proven themselves (again) in this crisis to be lagging indicators of onset of crisis – and of the recovery. Of course Spain is not AAA, but why downgrade them the day after they pass a good fiscal reform package and the central bank accelerates the regulatory framework that will help sort out the banks? As Dirk Schumacher showed in his piece in yesterday’s European Weekly Analyst, the Spanish private sector has already delivered more than half of the balance sheet adjustment needed to stabilise Spain’s net international investment position. Which leads me to my favourite topic: Adjustments! At the most fundamental level, where I disagree with the many Europe-bears out there (as opposed to Euro-bears; because I am one of those myself) is in my belief that Europe can adjust. We had 8-9 years of inappropriately fast convergence of income levels causing divergence of intra-Euro-zone ULC (and current accounts). Now we need maybe 3-5 years of a partial reversal: Convergence of ULC, which –unfortunately – will cause some divergence of income levels. This process is already under way via core deflation in several peripheral countries, including declining wages in Ireland and Spain. In other words, relative prices are moving in the right direction again. We all seem to broadly agree on the magnitudes needed for these adjustments, but disagreements emerge when we come to the issue of whether it’ll be politically and socially feasible to complete the process in each of the countries. Ironically, I have found that with respect to this assessment of the socio-political situation in each country , the further you get away from the Euro-zone, the more sceptical (and often the more convinced) observers get. Makes you wonder, doesn’t it?
4. Yesterday, Poland’s acting President Komorowski was reported to be about to nominate Marek Belka to be the next Polish central bank governor – and Belka is reported to have accepted. This is good news. Belka, currently the head of the European Department at the IMF, is an outstanding choice, a man with a fine academic background, followed by stints as both finance minister and prime minister. His recent statements indicate that he is not worried by the recent Zloty volatility and, in the longer term, supports Poland's entry into the Eurozone, provided that fiscal stability is restored. The date of the parliament's confirmation has not been announced yet, but this will be a formality.
Turning to this coming week:
5. The highlight in the Euro-zone this coming week will surely be Wednesday’s USD-swap auction by the ECB. Following all the drama of reported dollar shortage in the Euro-zone, it’s probably fair to think that the ECB was a bit relieved to see such a small take-up thus far. Those warning most dramatically about the imminent disaster have explained the low demand as caused by the expensive price (1.2%), but I am with the ECB on this one; this was a safety valve, so if there really was a need, they would have showed up. But with the maturing of unsecured USD funding coming up, we should probably expect to see a significant increase in participation this week. That said I suspect that a big number – say north of $20bn – between several banks (say 20) would raise eyebrows in the market and could restart another round of market volatility around the European banks. On the data front, apart from the final PMIs and revised Q1 GDP (probably no changes here yet), the key data point will be the Euro-zone unemployment number on Tuesday (E-map importance: 5); we expect a small increase to 10.1% (from 10.0%) – sad and headline-grapping as it is, the fact remains that labour markets are lagging indicators for the recovery. Also, on Thursday we’ll get the Euro-zone CPI for May; we expect an increase to 1.6% (from 1.5%) on the back of a small energy related base effect.
6. In the UK, the May PMIs are released this coming week (E-map relevance: 4), with Manufacturing on Tuesday, Construction on Thursday and Services on Friday. The consensus forecast is for each of the three PMIs to remain broadly steady in May, which seems reasonable to us; like for the Euro-zone we are coming towards the end of the long rally. Our Composite PMI – which includes the CBI Distributive Trades survey – was stable at 55.9 in April, consistent with sequential GDP growth of around 4% annualised. Were all else equal, then the fall in the CBI survey would imply a decline of around 0.8pts in the Composite index.
7. Switzerland publishes their Q1 GDP and the May PMI (E-map relevance: 4) on Tuesday. We expect the GDP to bear out the continued strength in the KOF and the PMI over the first three months of this year, so we are looking for a healthy reading of +0.8%qoq (non-annualised); slightly more optimistic than the consensus expectation of +0.7%qoq. With respect to the PMI, consensus expects a big reversal after recent months’ impressive gains (64.3, after April’s 65.9); we doubt there’ll be much of a correction.
8. Sweden will release the two key private-sector business surveys this coming week. On Monday, the KI/NIER Economic Tendency Survey for May is released (E-Map Relevance Score: 5). Though the headline index has slipped slightly in the last two months, at 105.6 it is still consistent with significant expansion. Given that the KI/NIER Survey lags the PMI by 1-2 months, we expect the May reading to push above 106. On Tuesday, the Swedbank PMI is released (E-Map Relevance Score: 5). In April the index rose to 64.0 – close to its all-time record high. While the forward -looking orders/stocks ratio was consistent with even greater strength in May, we nevertheless expect some decline from these giddy heights. Consensus is also forecasting a decline to 62.3.
9. There are two data releases of note in Norway next week. Retail sales (E-map relevance: 2) for April on Monday should come in at 0.8%mom, above consensus (0.4%) and the PMI (E-Map relevance 3) will probably drop back slightly to 51.0 after the large jump last month.
and that’s the way Europe looks tonight from Chiswick, while enjoying a bottle of Fuller’s local London Pride as a fitting warm-up for the weekend’s Danish brew.
Have a good weekend (and a long one for those in the UK and the US.)
Erik F. Nielsen
Chief European Economist