Economic Update: Germany Leads Euro Area Recovery
The euro area recession is over, but the ECB is not yet ready to raise rates.
A few months ago we noted that the global economy probably emerged from recession in the early summer, with Asia recovering earlier than the rest of the world. Since then the data has confirmed that most of the major Western economies returned to growth in the third quarter, with the euro area as a whole expanding by 0.4% and the US by 0.7%. The latter is significant from an Irish perspective, given the trade and multinational links between the two countries, but the performance of the euro area is of additional importance as it will determine ECB policy and hence interest rates for the Irish economy.
A number of euro countries, including Ireland, have yet to report third quarter GDP figures and of those that did not all returned to positive growth, with Spain, Cyprus and Greece still in recession. France and Italy did pick up, however, as did Germany, and the three together account for some two-thirds of euro GDP.
Of the largest economies, Germany, has proved the stronger of late, recovering in the second quarter and then growing by 0.7% in Q3, and as such the driver of the euro area upturn. Business spending on machinery and equipment has led the German recovery, with companies also re-building inventories in anticipation of higher demand in the future. Construction too has picked up, but all this has yet to feed through to the consumer – personal consumption had risen in the second quarter in response to a fiscal incentive on car purchase but fell back in Q3, declining by 0.9% in the quarter. The labour market has also benefited from a number of other fiscal initiatives by the Federal Government, and as a result the rise in unemployment has been relatively mild; the unemployment rate stands at 8.1%, having fallen marginally in recent months, and compares with a cycle low of 7.6%.
Despite the upturn the loss of output in Germany has been substantial and GDP is still 4.8% below the level a year earlier. Consequently, it will take some time for the Federal Republic to recover this lost output, and by extension for the euro zone as a whole. This implied level of spare capacity argues against any immediate inflation risk, and for the moment the ECB appears content to leave interest rates at the historic low level of 1% despite the recovery in euro area output. The Bank has also flooded the wholesale money markets with cash and it is in that area that some change is afoot, with December probably seeing the announcement of a reduction in the amount of ECB monetary support. This would mark a turning point of sorts in the cycle but the ECB is not yet ready to go further and signal higher interest rates.
Dr. Dan McLaughlin
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