Europe This Week: Commentary From Erik Nielsen

Happy thoughts from Goldman's Erik Nielsen

Happy Sunday,

For the first time this year I am writing to you from my backyard here in Chiswick; the weather is impeccable and I couldn’t think of a place I’d rather be right now.  A good cup of Nespresso certainly contributes to my well-being this morning, but more on that later.  Here’s my view of Europe right now:

  • It’s been another week of good real-economy numbers but with terrible markets.
  • Specifically, last week saw another batch of good growth indicators in the Euro-zone, including the PMIs.
  • Implementation of the Euro-zone’s mega-package is moving ahead; ECB continues its interventions in the sovereign debt market while policy measures are being rolled out.
  • The battle lines for future policy coordination (“economic governance” to the devoted) are being drawn; we are in for a long haul here.
  • Germany approved its share of the EUR440bn SPV.  Not much risk from here; I think it’ll be operational by the end of June.
  • Bank of Spain took over a small mortgage bank which refused the planned merger with a bigger bank.
  • The Swiss National Bank published numbers showing continued significant fx interventions in April.
  • This coming week we’ll look for further progress in the approval of the EUR440bn SPV.
  • On the data side in the Euro-zone, we’ll get (presumably) good confidence indicators from France and Italy.
  • The UK is set to publish the second estimate of Q1 GDP;  we expect a small further up-revision to 0.3%qoq.
  • Switzerland is set to print another strong Kof number on Friday,
  • Sweden is expected to print +1.2%qoq non-annualised Q1 GDP growth also Friday.
  • In Central Europe, we’ll get the Polish rate decision on Tuesday (no change)  and Czech elections on Friday and Saturday.


  1. We are through another week in the battle between an increasingly well functioning – if still fragile - real economy and financial markets spooked by a combination of concern about future growth and - as my boss Jim O’Neill has pointed out – a series of uncomfortable policy statements around the world with respect to restrictions, regulations and taxation of the financial markets.  Our central scenario for Europe remains one in which continued growth in the real sector (combined with the further implementation of good policy measures) will stabilise financial markets leading to a restoration of some (new) level of normality.  The key risk to this outcome is one in which dysfunctional financial markets stay with us so long that they’ll eventually strangle the real sector recovery.  My best guess would be that the real economy has another 3-6 months to convince financial markets that
    fundamentals are indeed improving before continued frozen credit channels would begin to sink the real sector back into recession.

  2. Last week saw further indication of the good European recovery.   Much was made of the decline in Friday’s Euro-zone manufacturing PMI for May (55.9 after 57.6 in April), although the services PMI increased to 56.0 from 55.6.  But did anyone really think that we were going to remain at the PMI levels from March and April– numbers which are consistent with annualised GDP growth of 3.0%-3.5%?  Surely, we didn’t correctly guess the timing of the flattening, but nobody could doubt that it was going to happen sometime, and mostly likely this spring; Germany was at a record high for manufacturing in April!  And there is probably still more to come; the May numbers are pointing to annualised GDP growth of about 2.8% in the Euro-zone, which is about double our forecast for 2010.  The more important news than the overall decline was the still strong level and the fact that the employment indicators pointed to job creation for the first time in two years – looking like a pretty good recovery to me.  Then there was the Ifo which fell marginally to 101.5 (from 101.6), and while general expectations were easing and the retail component declined (a concern, indeed, but who didn’t know Germans are reluctant shoppers), manufacturing showed further increase in confidence.

  3. Implementation of the Euro-zone mega package is moving ahead.  Remember that there are four components to the package: (a) the ECB’s interventions in the sovereign debt market; (b) policy reforms in the individual countries to restore fiscal sustainability and growth; (c) tighter policy coordination going forward; and (d) a 3-year EUR500bn rescue package, including an EUR440bn SPV (all possibly supplemented by EUR250bn from the IMF).  First, the ECB announced early last week that they had spent EUR16bn on purchases during the first few days of the program; I suspect that they have spent another EUR15-20bn since then; still peanuts in the bigger scheme of things.  Second on policy adjustments, French president  Sarkozy imposed restrictions on all tax measures to the Finance Bill (or revisions thereof) thereby eliminating ministers’ ability to attach loopholes on the revenue side to other legislation.  Its part of the big constitutional plan, but the current government will apply it immediately.  Maybe more prominently reported, Sarkozy also announced plans to introduce legislation – to be enshrined in the so-called “Fundamental Law” - obliging governments to start a process of balancing the budgets from 2012, but details here remain vague and discussions with the opposition will start only after summer.

  4. Third, policy coordination is a big-ticket item and one that’ll be with us for a long time.  I outlined the Commission’s proposal last weekend, and the Ecofin has been hard at work since.  The lines are still being drawn up between the countries; I predict that we are in for an epic battle between the traditional net payers and net recipients of cash within Europe (at least those who haven’t weakened their negotiating positions due to the crisis.)  German finance minister Schaeuble has distributed a nine-point plan, which includes procedures for an orderly state insolvency mechanism.  Meanwhile, a number of prominent Italians, including former PM and Commission president Prodi and former finance minister and ECB GC member Padio Schioppa, have become increasingly vocal in their call for the introduction of fiscal federalism in which – ultimately – tax revenues will be shared to a larger extent between member states.  Needless to say, anything more than a gentlemen’s agreement (supported by peer pressure – not to be underestimated in the present environment) would require a change of the treaty, so we are in for a very long haul here.

  5. Finally, the fourth component – the SPV – is moving closer.  The German parliament approved the German share of EUR123bn on Friday.  In the end it passed with a very comfortable majority, but - apparently triggered by doubt about its passing on Tuesday - the government announced unilateral and immediate (if temporary) ban on various types of shorts, which yet again knocked over financial markets.  My guess is that the SPV will be fully approved and the practical details sorted out around the end of June.  At that stage, if a Euro-zone member should face problems funding itself in the commercial market, it can apply for a loan from the SPV.  Such an application would trigger negotiations on policy conditionality (like an IMF loan), and when agreed, the SPV would raise the necessary funds in the market against the guarantees (pro rata), and money would be disbursed in tranches following a decision by qualified majority by the European Council.  I presume that this would happen in tandem with an IMF loan.  In my opinion, this will be a powerful mechanism that ought to provide a lot of comfort to the market.

  6. One of the most discussed topics among investors these days is the European banking system, and particularly the Spanish one.  Unfortunately, many discussions are flavoured by limited information and general distrust of the publicly available data.  In reality, of course, the Spanish bank restructuring plan is moving ahead, and while one could always wish for more speedy operations, there are – fortunately - processes which need to be followed when governments interfere in the private sector.  In the case of Spanish bank restructuring, the European Commission postponed the deadline until the end of September by when all cajas in need will have to submit their restructuring or merger plans, but three weeks ago PM Zapatero and the leader of the opposition agreed to speed up the process and bring the deadline forward to the end of July.   And for the really serious cases, action is taken earlier, as illustrated by this weekend’s takeover over of Cajasur by the Bank of Spain.  Cajasur is a small savings bank operating in Andalucia with just 0.6% of the banking system’s assets, so it should have no implications for financial stability.  The problems in Cajasur were identified long ago and the authorities had been pressing for a merger with Unicaja, a much bigger institution.  The take-over came after Cajasur finally rejected the merger on Friday; the FROB (the fund set up to shore up the capital base of the weaker banks) has been appointed as manager.

  7. The Swiss National Bank has long intervened to prevent unacceptable appreciation of the CHF.  This past week they released their balance sheet for April, showing a stunning 23% increase in the line-item quantifying their foreign currency investments; that’s an indication of some CHF29bn in interventions in April to stem the fx appreciation.  As the SNB have accumulated considerable fx-denominated assets on their balance sheets, needless to say, they have exposed themselves to financial risks, something some investors seems almost obsessed about when it relates to the ECB’s recent (and more modest) asset purchases, but which is seldom discussed in the case of the SNB’s fx interventions.  For a discussion of the financial risks associated with the SNB’s interventions, see Dirk Schumacher’s piece in the European Weekly Analyst three weeks ago.  (Incidentally, the upward pressure on the CHF brings me back to my lovely Nespresso; now long consumed.  If you sell quality products, then there are plenty of hungry (and thirsty) consumers out there – and Switzerland is far from the only European country with the luxury of an export basket with great pricing power. )

Moving to this coming week:

  1. We’ll keep a close eye on the further progress with respect to the national approvals of the SPV, although we do not think there is any measurable risk of it not being passed in all the major countries.  As far as I know, it is not yet on the parliamentary agendas in France or Italy, and the Spanish government says that it has requested more details from the Commission before they’ll submit it for a vote.   The Netherlands have approved their share already.

  2. This coming week should bring further evidence of the growth recovery – in the shape of some important confidence indicators for May.  In Italy, the ISAE survey of business confidence will surface on Tuesday (we expect a slight increase from 85.5 to 85.8, (EMEA-MAP relevance 4)).  In France, the analogous INSEE survey (Wednesday) should register a small decline, to 96, after an outsized gain the previous month (EMEA-MAP 2).  For the consumer confidence counterparts of these surveys (due out on Tuesday in Italy and on Wednesday in France, EMEA-MAP 1 and 2 respectively), we expect minor improvements.  Also, German states will start to release their May CPI prints this coming week and we should have country-wide preliminary estimate on Thursday: we look for +0.1%mom and +1.2%yoy, after +0.9%yoy.  Spain will also publish its flash CPI on Friday: we see it at 1.7%yoy, after 1.6% in April.

  3. There is only one release of note this coming week in the UUK, namely the second estimate of Q1 GDP on Tuesday.  We expect an upward revision to 0.3%qoq (from 0.2%) on its way to a final much higher numbers in a couple of years, as discussed by Ben Broadbent and Kevin Daly in recent months.

  4. The recovery is far from limited to the Euro-zone.  In Switzerland, most importantly, the May out-turn of the KOF Leading Indicator (EMEA-MAP Relevance Score: 5) will print on Friday.  It is perhaps inevitable that the rapid acceleration in the KOF will begin to fade, but the fact that both the PMI and the KOF have shown such strong gains over a consistent period suggests that there is still room for further upside in this key indicator of Swiss economic activity.  We are in-line with consensus, expecting modest gains from 1.99 to 2.03.

  5. In Sweden, Q1 GDP will be released on Friday.  We are above-consensus, looking for +1.2%qoq (non-annualised) growth against the market’s expectation of +1.0%.  However, in the context of the volatility observed in early GDP releases in Sweden, the difference between our forecast and that of consensus is small.  Preliminary GDP releases have an EMEA-MAP Relevance Score of 4 (rather than the maximum 5) because of the considerable revisions that occur to early vintages of the official data.

  6. In Central Europe, the Polish MPC meets on Tuesday to consider its monetary policy stance (no change in interest rates), and on Friday-Saturday voters in the Czech Republic will choose a new Parliament.  Opinion polls allow for a wide range of possible outcomes: up to seven parties may make it into the lower chamber.  The centre-left Social Democrats will likely get most votes, but it is far from certain that they, together with a possible ally in the Communists, will be able to secure more than half the seats in the lower chamber (and as Anna Zadornova has observed, even if they were able to, President Klaus might work hard to prevent such an alliance from forming).  A rightist coalition is also possible, but this would require cooperation from the centre-right ODS and several smaller parties, raising questions about its sustainability.

and that’s the way Europe looks on this beautiful morning in Chiswick.  I hope that wherever you are its at least half as good as it is here.

Erik F. Nielsen
Chief European Economist
Goldman Sachs