30 Oct 2019

Following a strong first quarter of the year for economic activity, the pace lessened in Q2, with growth recorded of only 0.2%.  This was broadly in line with expectations as weakness in Germany dragged down the Eurozone as a whole.

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The Iberian peninsula countries of Spain and Portugal, together with the Netherlands, led the way with growth of 0.5%, but France, Italy and Austria all performed less strongly than in the first quarter while Germany was actually in negative territory.
Undoubtedly the amount of uncertainty over the direction of Brexit will not have helped anyone on the Continent with export markets in the UK
The principal explanatory factor behind this outcome was the weakness of global trade, where Germany has a heavy reliance on exports, but its cause was not helped by ongoing difficulties in the car industry following the emissions scandal and by lingering concerns about the navigability of the River Rhine, a main trade route for German goods.  The September reading of the German Manufacturing Purchasing Managers Index (PMI) sank below 42 (with a value of 50 indicating unchanged conditions) and pointed to the steepest decline in output for a decade.  
By contrast French PMI data showed an outcome of 50.1, though Italy and Spain both reported outcomes lower than in August and below the 50 level.
Unemployment across the Continent has continued to decline, with the rate for August reaching 7.4%, only a fraction above the low point of the past twenty years and materially lower than the peak of 12% recorded during the winter of 2012/13.   The range of principal countries extends from Germany at the low point of 3.1% (unchanged over the last three months despite the economy retreating), to Spain at the high point of 13.8% (continuing to fall on a monthly basis), with France also unchanged over the past quarter at 8.5% and Italy at 9.5% also continuing to drop.
This positive backdrop is supportive of consumer confidence, which has proved to be much more resilient than business equivalents in the past few months, and should enable spending to remain on its current modest uptrend.
The escalating level of friction in international trade will undoubtedly hit the Continent hard and fears of that were behind an easing of interest rate policy by the European Central Bank (ECB) at its September meeting.  Undoubtedly the amount of uncertainty over the direction of Brexit will not have helped anyone on the Continent with export markets in the UK.

August's rate of unemployment across the continent
Germany's rate of unemployment
Spain's rate of unemployment
Mr Draghi as head of the ECB unveiled a cut of 0.1% in its deposit rate, taking it to -0.5%.  He is soon to hand over the reins of the Central Bank to Christine Lagarde, formerly at the International Monetary Fund (IMF).  She will assume office with effect from the beginning of November, having spent about eight years as Managing Director at the IMF. Mr Draghi will chair one further meeting of the ECB Council in late October.
In addition to the lowered policy rate, the ECB decided to resume its programme of quantitative easing (QE), by committing monthly amounts of €20bn with effect from the beginning of November.  Given the previous phase of QE included an effective ceiling of purchasing no more than one-third of any member Government’s bonds, it is easy to see why markets concluded that renewed demand for bonds from the ECB and limited supply (in light of the narrowing fiscal deficits) might lead to even more negative yields.
Money Supply indicates PMI should bounce in the next few months

Money supply indicates PMI should bounce in the next few months

Source: BofA Merrill Lynch Global Research, Haver

Some encouragement amongst the gloom is offered by the chart above, which illustrates that money supply in Europe has resumed its uptrend after the dip in Q2 and has now surpassed the peak of spring 2018.  Should international tensions dissipate and domestic demand continue to be solid, then the current bleak path for PMIs could reverse. 
In that regard European equities, rather like the UK but for entirely different reasons, have been neglected by global investors and look cheaply rated.  Though analysts have reduced profit forecasts for Continental equities as the months have passed since the spring, their expectation is still for 4% growth in calendar 2019 and 8% next year.  The dividend yield of c3.5% is very appealing compared with the potential returns from bonds.  In the latest quarter, shares recorded very modest gains, with Italy and France in the vanguard.

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