European recovery and shifting sentiment

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European recovery and shifting sentiment

The economic recovery in Europe gathered momentum last year, continuing to surpass growth in the UK, US and Japan.

GDP in the Eurozone is now trending well above 2%, with forecasts expecting growth to stay around the 2% level this year and next. This is good news but it does represent a fading in the trend rate of growth.

Forecast growth (dotted lines) show jockeying for leadership, with the US and Japan both forecast to reaccelerate. Growth in the US is expected to flatten first but as tax cuts kick in the economy gets another boost. The UK is lagging behind and forecasts show an anaemic pattern but as we discuss later there are some reasons for optimism.

Annual Real GDP Growth

Source: Bloomberg, April 2018.

Improvement across the Eurozone has been ignited by the European Central Bank’s (ECB) stimulus policies and efforts by national governments to introduce country specific fiscal recovery programmes. The leading driver behind the recovery has been Germany, with strong exports, low unemployment, surging tax revenues and a combination of rising real wages and historically low interest rates. These factors have been fuelling consumer spending.

Recent commentary by economists has focused on softening trends in Europe. For example, the Purchasing Manager’s Index (PMI) Composite, seen as a good overall indicator of sentiment, fell to 55.2 in March from 57.1 the previous month. The highest reading of 58.8 was reached in January this year and so the overall trend is down. Nevertheless, it is worth remembering that a reading above 50 indicates expansion. Readings closer to 60 are rare and unsustainable.

Eurozone Composite Purchasing Managers Index

Source: Bloomberg / Markit, April 2018.

A less well-known data set is produced by Citibank. It is called the Citi Economic Surprise Index. This measures the level of surprise relative to market expectations. A positive reading means that data releases have been stronger than expected and vice versa.

Last year the reading was positive and trended higher but in recent months the index has seen a rapid decline, with the latest reading at -91.5.

Citi Economic Sentiment Surprise Index

Source: Bloomberg, 17 April 2018.

As this decline has taken place over the last 6 months it suggests European economies are making a weak start to the year. The decline also coincides with strength in the Euro and, in recent weeks, worries about trade tariffs is thought to be impacting business sentiment.

On a more positive note, Eurozone countries will benefit from continued slack in the labour market allowing firms to increase their output and productivity further without much pressure on wages. Weaker data points also provide information to policy makers and these signals will encourage the ECB to maintain its strong monetary policy support through low interest rates and continued Quantitative Easing programme.

With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. Past performance is not a guide to future performance. Tax rules can change at any time. This blog is not personal financial advice.

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