The “R” Club Is Recruiting

The “R” club is recruitingThe EMU has not had the desired unifying impact

Germany is on track for a technical recession, like Italy. Growth should return in 2019, but slower EM means slower Germany. Among main calls for 2019, the analysts of BoAML are the euro area inflation at 1.0% on average, tricky for the ECB but good for purchasing power. These following are their arguments:

GDP fell in both Italy and Germany in Q3, but while for the former the consensual – and our – view was that obvious recessionary forces were at play, one-offs were still the dominant explanation for the latter. Unfortunately, it seems that Q4 is not bringing any relief to the German economy. We are tracking another decline in GDP by 0.1% qoq. While we are the first to find the focus on one-offs tedious and often misleading, we actually believe we can ascribe roughly 50% of the drop in IP in Q4 to such factors. Still, that Germany, which has been pursuing an export-led growth strategy with a focus on EM, starts struggling when the global cycle is softening should not be a surprise. Weak demand from China is a key problem. Germany is facing only a “technical” recession – a robust labour market, disinflation and a timely fiscal push should ultimately support growth – but the slowdown of its economy is no less real.

Not much better in the rest of the Euro area

Elsewhere in the Euro area things are not looking much better. We review our main calls for the key member states in the weekly view. France avoided a GDP contraction in Q3, but the steep decline in IP in November, even before the “yellow jackets” movement was in full swing, is not making us very confident. In our “hot topic” we revisit an exercise we already conducted in late 2017, disentangling the effect of a common European deterioration in confidence from country-specific shocks. Unsurprisingly, France has been recently hit by an idiosyncratic collapse in economic sentiment. In Italy, the resilience in consumer confidence remains impressive. The population there has not yet followed the business sector in a downward revision of their expectations.

ECB’s sweeteners for a bitter brew

Our baseline remains that the trough is near. The end of Q1 could be the “grimmest moment” for Europe. Chinese data won’t necessarily have started to respond to the policy easing there, while the news-flow from the US could still be concerning. A “no-deal” exit at the end of March would have a substantial impact the Euro area. Hopefully, some decent traction in the US, a rebound in China combined with the domestic fiscal easing and lower oil prices (we revised our inflation forecasts for 2019 from 1.6% to 1.0%, more details in our weekly view) should allow for a re-acceleration in Europe from the end of Q2. Still, we continue to think the ECB will have to give us some sweeteners come March. However, a variable-rate TLTRO and a timid revision in forward guidance would offer little support. If we are wrong and the Euro area needs to deal with a prolonged downturn, we think even more fiscal easing will be unavoidable.

Brexit in the hands of parliament

The resolution of Brexit remains as elusive today as it was before the holiday break. The new development is that parliament is now severely curtailing the Prime Minister’s room for manoeuver. Our impression was that T.May was “playing the clock” and closing all other options than the deal she had negotiated with the EU as MPs would panic as the 29 March deadline approaches. However, MPs have decided to give her only 3 days, instead of 21 days, to come back with another solution should she lose the vote on her deal next week. There is clearly a majority in parliament against a “no deal” solution, but we still fail to see what kind of majority can be found for any deal.