What about the slowdown in eurozone growth | MarketMinder

After the surprising contraction in US first-quarter GDP last Thursday, Eurostat on Friday reported slower but positive first-quarter eurozone GDP growth of 0.2% q/q, with mixed output in the four largest savings.[i] The report is not all sunshine and roses in all sections. Yet, rather than encouraging the resilience of the currency bloc, headlines warned that the slowdown could portend a recession brought on by the Russian-Ukrainian war and high prices. Although the Eurozone GDP figures for the first quarter do not tell us much new on the economic front – and we do not rule out the possibility of a regional recession – the reaction to these reveals to how universally gloomy the sentiment is in Europe today.

Of the 19 members of the euro zone, 7 published their first quarter GDP on Friday.[ii] Portugal (2.6% q/q) and Austria (2.5%) led the way, but most of the headlines focused on the four largest economies.[iii] While Germany (0.2%) and Spain (0.3%) advanced, France stagnated (0.0%) and Italy contracted (-0.2%).[iv]

Exhibit 1: Change of Quarterly GDP of euro area countries, Q2 2021 – Q1 2022

Source: Eurostat, as of 04/29/2022. Quarter-over-quarter real GDP growth rate, Q2 2021 – Q1 2022.

The consensus estimate for euro zone growth in Q1 was 0.3% q/q after 0.3% last quarter, so some argued the weaker-than-expected result signaled mounting war pressures in Ukraine and soaring energy prices.[v] A separate Eurostat report on Friday showed the Harmonized Index of Consumer Prices (HICP) rose a record 7.5% year-on-year in April – with energy prices rising by 38.0% – prompting some to conclude that the economic situation could worsen further since energy tensions with Russia are building.[vi]

Although Eurostat’s initial estimate does not provide much detail on the underlying components of GDP, national statistical agencies have highlighted some country-specific trends. According to the National Institute of Statistics and Economic Studies (Insee), French GDP stagnated due to weak domestic demand: household consumption fell by -1.3% q/q, with services hotel and catering (-5.3%) and purchases of goods (-1.7%) which harms the most.[vii] This weakness appears to be related to COVID restrictions earlier this year when Omicron made headlines. Now, this hard data may seem inconsistent with the message of the purchasing managers’ indices (PMI), especially since the French services PMI showed an expansion from January to March.[viii] But PMIs reveal the extent of growth, not its magnitude – other service industries have grown, but perhaps not enough to offset weakness in COVID-affected industries. As INSEE also noted, both transport services (1.9%) and household services (0.5%) grew, although at much slower rates than in the fourth quarter.[ix]

German Destatis provided less detail than its French counterpart, but the agency attributed the first-quarter growth to higher capital formation (which includes domestic investment and inventory changes) and noted that the trade balance (exports minus imports) weighed.[x] Future estimates should provide more color, as some of these components of GDP are subject to interpretation. As we noted in our commentary on US GDP, inventory changes are not automatically good or bad. For example, if the change in inventories adds to GDP, companies can build inventories in anticipation of demand (good) or companies might struggle to move the (not so good) product. In our view, the former is more likely, as demand for constrained goods – strained by supply chain issues – still looks strong. Similarly, if the boost came from business investment, that would also be a plus. Destatis also noted that the Russian-Ukrainian war added more near-term unknowns, which may subject the results to greater uncertainties than usual.

The limited amount of hard data hasn’t stopped pundits from releasing a series of stark shots, most of the stories focusing on the same themes: war-related disruptions will drive up high energy prices, plunging Europe into an energy crisis and making recession inevitable. However, the prevailing skepticism has overshadowed some better-than-expected realities. Take Germany. Over the past two weeks, many pundits have warned that the eurozone’s biggest economy will contract again in the first quarter, plunging the country into a recession by a popular definition. Official figures confirmed that this did not happen, but many seemed to put this better than expected outcome on the back burner and instead focused on worse than expected GDP figures from France and Italy.

To be clear, we are not dismissing the continent’s economic headwinds. The inflation rate is expected to remain high for some time, weighing on both businesses and households, and we sympathize with those suffering from these difficulties. But many of today’s dire projections are extrapolations of worst-case scenarios, for example, the EU or Russia suddenly severing energy ties, leaving the continent short of supplies. Yet, as we recently pointed out, the reality is more complicated than that. Movements against Russia so far are small, and potential future and larger EU moves are also likely to be progressive – if they can overcome objections from some members (Hungary, Austria) and bring into implemented an energy embargo. Despite harsh rhetoric from politicians, there are many unsettled details regarding a possible EU ban on Russian oil, not to mention unknown implementation timelines. Even so, Europe finds energy elsewhere: see the natural gas exports from the United States, Qatar and perhaps even the United Kingdom. While not a perfect substitute for Russian energy, the alternatives cushion the blow. Moreover, available economic data suggests that Eurozone businesses continued to expand early in the second quarter despite the raging war. We see few signs that this regional conflict is turning into a larger conflict capable of engulfing the Eurozone economy, let alone the global economy.

We are monitoring the situation closely because war and politicians’ responses to it are inherently unpredictable. But given how widely discussed a Eurozone recession is at this point, markets likely priced in some economic weakness. Recent Eurozone returns underscore this.[xi] In our view, this also portends a positive upside surprise should the reality turn out to be slightly better than the widely expected pessimism today.

[i] Source: Eurostat, as of 04/29/2022.

[v] Source: FactSet, as of 04/29/2022.

[vii] “GDP stagnated in Q1 2022 (0.0%)”, Personnel, Insee, 04/29/2022.

[viii] Source: FactSet, as of 04/29/2022.

[x] “Gross domestic product at 1st Quarter 2022 up by 0.2% compared to the previous quarter”, Personnel, Destatis, 04/29/2022.

[xi] Source: FactSet, as of 04/29/2022. Statement based on the return of the MSCI EMU Index with net dividends, 31/12/2021 – 29/04/2022.

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