The eurozone economy has experienced a sharp slowdown since the second half of 2018 in a reversal from the mini-boom enjoyed in 2017. This downturn has been most pronounced in the manufacturing sector and in Germany, due to its heavy exposure to weakening foreign demand and temporary setbacks that stalled its auto sector. While uncertainty relating to global trade tensions, Brexit and other European political headwinds will likely continue to take their toll in the near term, we at Invesco Fixed Income believe the eurozone economy will recover, growing toward trend level in the second half of this year.
Although we do not predict an imminent surge in global demand, we believe a gradual recovery in foreign trade on the back of accommodative policies and loose financial conditions abroad should eventually benefit European industry. Adding to that, resilient private consumption, easy monetary policy in Europe and the resolution of Germany’s temporary production bottlenecks are likely to support the eurozone economy through the rest of the year.
Figure 1: Eurozone real GDP growth and PMI surveys
Source: Eurostat, Markit, data from May 20, 2019. The Index label on the left axis refers to the Markit Eurozone indexes shown (SA stands for seasonally adjusted). GDP refers to gross domestic product. PMI refers to purchasing managers index. RHS means right hand series and QoQ means quarter on quarter — the change in value at the close of each three-month period.
Domestic demand continues to be supportive
Economic data have continued to show a stark contrast between a strong services sector and struggling industry. We expect employment and wage growth to support private consumption in the near term as labor scarcity seems to be translating into moderately higher wages. With continued low inflation, these developments should improve disposable income and support consumption growth.
Chinese green shoots not yet showing in European manufacturing data
With China’s improved growth momentum in the first quarter of this year, the question now is when will this improvement feed into eurozone manufacturing performance? Eurozone growth was higher than expected in the first quarter of 2019 (0.4% quarter-on-quarter, up from 0.2% at the end of 2018).1 However, continued weakness in second quarter European survey data has diminished hopes of a major turnaround in the European economy. Recent Chinese stimulus has been smaller relative to previous rounds and has focused more on infrastructure than credit policy — this could be leading to smaller (and slower) spillover to other economies. Nevertheless, we expect Chinese stimulus to provide some boost to the eurozone economy with a lag of three to six months.
Escalating trade tensions between the US and China could also weigh on the production decisions of European manufacturers, and the risk of increased US tariffs on European cars and parts (a decision now delayed to November 2019) could further dampen sentiment. On the other hand, the weaker trade-weighted euro and overall stronger global growth are bright spots for Europe’s manufacturing outlook. We believe a modest recovery still seems possible over the course of this year.