Q1-08 Eurozone GDP - A Last Salute from Germany?

The preliminary and 'non-broken up' GDP figures for the Eurozone economy are now out for the first quarter of 2008. In many ways, I have been in a bit of GDP mode this week as I both made a sneak peek to the Eurozone release as well as I concluded that the Baltics have now entered a recession (a post which even made it to the front page of Moneyweek.com; thanks for that plug.) From a market perspective such ardent attention is surely not warranted. I hardly think markets moved more than a few digits on today's news most likely because the result was already priced in albeit not the 1.5% from Germany I imagine. Yet, what did we get from today's Eurozone GDP release? Well, let us visualize the figures.

As can be immediately confirmed today's release is all about Germany which posted an unprecedented expansion of 1.5% q-o-q. Also interesting was Spain's obvious slowdown and Italy's continuing absence from the data (we are supposed to get figures from the stats offices the 23rd of May). However, let us have a look at what happended in Germany and where that hefty 1.5% reading comes from. As Edward detailed back in March the first two months of January and February were very strong in Germany before momentum levelled off considerably in March and now as well in April and quite possibly May. So far we don't have a detailed break up of the figures but it is safe to say that the expansion in Germany was driven primarily by corporate capex and specifically construction. Moreover, this strong showing of corporate investment is also a derivative of strong external demand which is also sure to have contributed favorably to today's figure. This is not to say that domestic demand and consumption were not significant but given the level of the figure I am very confident when I say that the main driver was not consumption expenditures. Having said that 1.5% still seems to be an almost extreme number. I have been busy talking with my colleagues about this and one of the reasons we have settled is the seasonal factor. Basically, the mild weather which is widely cited means that a lot of work would have been advanced. Also, my colleagues made the point that the y-o-y figure at 2.6%, albeit strong, was not strong enough to merit 1.5% q-o-q. So, this is merely to say that before you go out talking about annualised figures of 6% you would be wise to consider the underlying momentum. Turning to the other big four Eurozone countries we observed, as expected, a significant slowdown in Spain where the global credit turmoil has now decisively spilled over into a slump in construction and housing hitherto the hallmarks of the Spanish growth spurt. A contraction in domestic demand is consequently cited as the main culprit in Spain's case. Germany should of course be looking more than careful here since Spain is one of the 10 biggest customers of German exporters. In many ways, the sub-par Spanish showing is also historical since it marks the first time in a considerable number of years that Spain is trailing the Eurozone average. Based on the correction which now seems to be materialising this could very well mark a structural break as Spain is now set to position itself on a lower growth plateau. In France, GDP continued to muddle along quite nicely at 0.6% and in many ways France seems to have taken its newly found label (branded her here among other places) as the Eurozone's Mme Average. Undoubtedly, France will slow too but I don't think we will see an actual contraction here. A relatively buoyant domestic consumption factor will prevent this as Edward tries to explain here. The last economy amongst the big four is Italy which again opted not to release its figure. Presumably we are supposed to get figures for both Q4 07 and Q1 08 later this month as noted above. Meanwhile we are left guessing. Most economists agree that Italy may have already tumbled into a recession in Q4 2007. As for the current figure it is difficult to say. Clearly, Spain's lacklustre performance cannot in itself have dragged down Germany's 1.5% to 0.7% as was the aggregate figure.

 If we look across the rest of the Eurozone edifice the result was mixed which indicates that a marked slowdown here is not the explanation either. This pretty much leaves Italy (and Ireland from whom we did not get figures either) to explain why Germany's impressive showing did not push the aggregate figure into the +1% territory. Back of the envelope calculations suggest (see below) that Italy was probably very close to flat in Q1 assuming that the 0.7% figure includes any implied Italian weight at all. At this point it is very difficult to say but can be inferred with some certainty is that Italy was the first Eurozone economy, together with Ireland and Spain of course, to be tussled into the ropes and very likely onto the canvass as a result of the global slowdown. As I have explained again and again this is no coincidence and Italy's situation can consequently be explained through a mixture of unfavorable demographics and institutions where I tend to look more closely at the former than the latter. If we peer across the rest of the Eurozone edifice a couple of things should be noted. Most prominently the Netherlands, who after all account for some 6% of the aggregate economy, slowed considerably posting 0.2% q-o-q. Greece continued to expand at 1.1% while Portugal contracted -0.2%.

So, where does it go from here?

To answer this question we could do a lot worse than visit the recent monthly ECB bulletin out today. In words and graphs it paints a picture of a slowing economy across the board noting in passing the factors such as mild weather and strong external demand in the context of Germany which provided to deliver the impressive Q1 figure. In particular, industrial production as well a the leading indicators in the form of new orders are mentioned to have contributed strongly (although the latter of course does not contribute anything material). The ECB's researchers also emphasise that the construction rebound is likely to be short lived. In Spain and Ireland in particular we have seen a sharp correction but also construction confidence indicators have fallen throughout the beginning of 2008. More worryingly in terms of the general economic outlook business activity and leading PMI indicators in the context of the service industries show a decisive downward trend. Services as we know account for just shy of two thirds of the Eurozone economy. In the most recent print edition which I imagine is going through the printer as I type the Economist is furthermore duly cautious in terms of extrapolating on the basis of today's figure. The failure of domestic demand to take over in a situation where corporate investment falters is one of the important points. Of course as the Economist also points out, the reluctance of the ECB to provide stimulans on the interest rate front has straddled up government officials to knit together fiscal stimulus packages. The first of these to be brought into effect will be in Spain where the budget is actually fielding a surplus. In Italy and Germany where fiscal balances are much more tight plans are also in the smelter. This however is going to result in more attention from the EU in the context of those Maastricht convergence criteria; especially I imagine in the context of Italy who is already running a rather gung-ho fiscal policy.

In order to summarize on the outlook the Q1 2008 expansion is not likely to last. I am especially looking for a marked slowdown in Germany after the extreme 1.5% reading this quarter. In my opinion Germany may thus very well see a contraction in Q2 on a q-o-q basis. I also think that Spain will continue to trail the sub 0.5% figures and possibly even a contraction in q2 and q3 depending on how far and severe the correction in construction and housing is. This points to considerably lower aggregate figures for the rest of 2008 and possibly even negative numbers at some point. In this light, Italy also needs ardent watching. Evidence suggests that Italy not only may already be in a recession but also that the downturn may be lasting and inelastic. In short, after what can only be seen as a swan song in Q1 2008 the risk and direction is now entirely to the downside. Once Germany slows down which it almost certainly will in Q2 we will see the real effect in the Eurozone.

In this light an important question is whether the ECB will react to today's release. Certainly, reduction of interest rates can hardly be justified on the back of this figure. However, given the backdrop which is certain to come in Q2 as well as the much welcome sign that the increase in annual inflation rates are easing you cannot but think that the ECB's bias is about to change. It is not however going to change swiftly. Inflation is still way above the comfort level and even though news of lower global food prices in April rolled in over the wire today I hardly think we are out of the inflation woods yet. The underlying tendencies are too strong I think. For more on this Macro Man's recent invocation of the three axioms of globalization is an excellent place to go. Consequently, I don't quite see the ECB moving its bias in public yet even though the cycle is now certainly turning.

Appendix 

The flat growth rate for Italy is found relatively simple but obviously assumes that the 0.7% figure includes Italy at all. As such, if we take the 2007 GDP in current market prices we are able to assign the following weigths ...

Germany - 27.3%  

France - 21%      

Italy - 17.3 %

Spain - 11% 

The Netherlands - 6.3 %

Belgium - 3.7% 

Austria - 3.1%

Greece - 2.5%

Portugal - 1.84%

As can be confirmed this amounts to 94% of the entire Eurozone. If we further calculate the weighted average of these countries' growth in Q1 (excluding Italy) we get a growth rate of .644% already for 76% of the Eurozone's countries ex Italy and Ireland. This leaves us with this simple equation where G is the implied growth rate of Italy, Ireland, Slovenia and the rest of the small Eurozone countries.

G = (0.7-0.644)/(1-0.76) = 0.23%.

Now, we know that Slovenia grew smartly which leaves us with Ireland and Italy to share something like 0.15% which is basically flat. Of course, if one of these countries saw a sharp contraction then it means the other must have grown. Especially since Italy accounts for the largest weight by far it cannot have expanded much. I am not sure my method is valid though. In fact, if we include Slovenia it seems as if you hit 0.7% without including Ireland or Italy which may be the way the numbers have been calculated.