Euro-area: Down, if not out

Thursday may be the date that the euro-area moves one step closer to recession, should Eurostat announce a negative growth figure for the 15-member bloc for the period between April and June. The first quarter had seen an unexpectedly strong growth of 0.7% compared to the previous three months, and 2.2% on the same period a year earlier. This was largely driven by an impressive German performance of 1.5% quarter-on-quarter but the euro-area’s second largest economy, France, also surprised with good results. However, much has changed since then.

Consumer, business and investment sentiments are at their lowest levels since records began. Retail sales saw the sharpest annual drop in 13 years in June, with not a single euro-area country reporting a growth in the sector.  Unemployment saw its first increase (albeit very slight) in 24 months.  Together with rapidly falling house prices, more expensive and less available credit, higher cost of living costs due to soaring food and fuel prices (inflation hit an all-time high of 4.1% last month), domestic demand (especially consumer spending) is likely to suffer.

The export side -- having held up for now, especially in world number one exporter Germany -- does not look much more promising. The euro continues to be exceptionally strong compared to other major currencies, making euro-area products unattractive.  Moreover, households and businesses in the EU’s key export markets are suffering from the same economic and financial constraint as their European counterparts and thus consuming less.

The euro-area upswing of the past two-an-a-half years is at an end, with ‘housing boomers’ Ireland, Spain and Portugal facing a severe downturn, if not recession. However, a technical recession is not a certainty: firstly, bad German figures may simply reflect a difficult act to follow -- the strong growth in the first quarter was always going to be hard to repeat for another three months. Secondly, relatively high wage settlements in Germany, but also other euro-area countries, are starting to take effect, and private consumption might well pick up in the third and fourth quarter. Inflation will become a headache, but growth may be propped up.