November: A crucial month for Europe

October 31, 2019

Despite hopes for a bottoming out, data streams through October showed that the eurozone economy is still struggling. The crux of the problem lies in its manufacturing industry, which has taken a hit from the US-China trade dispute. However, with those two sides seemingly on the brink of signing a mini-deal, there is now a danger that the US’ gaze will shift to the EU, and perhaps European industry will face a direct blow, on top of the collateral damage it is already grappling with.

While the US and China took swipes at each other, global trade plummeted, against the backdrop of a global cyclical slowdown. In turn, demand for Europe’s exports (a lot of which are industrial machinery) declined drastically. PMI data released in October shows that the manufacturing sector remains in a slump. The bloc’s Manufacturing PMI was unchanged in October at 45.7, below expectations of 46 – anything below 50 indicates economic contraction. Germany’s manufacturers have been particularly hard hit and the Bundesbank has already cautioned that the country could be in a recession you too (two consecutive quarters of negative growth), after having shrunk by 0.1% in Q2. Official figures for Q3 are due November 14th. Unlike trade-dependent Germany, the French economy is proving to be more resistant to the global economic slowdown, and Q3 growth came in at 0.3%. Exports contribute only 31% to France’s GDP, vis a vis 48% for the eurozone. The country also has a greater share of services, at 70% of its gross value added.

It seems that across the broader eurozone, the Service sector has remained somewhat resilient to the malaise in manufacturing – the Service PMI for October delivered the green shoot that optimists were looking for, rising to 51.8. But the question is – can this last? The incoming new business index of the eurozone’s services PMI fell to its lowest level in almost 5 years and is consistent with private sector services output growth slowing sharply over the second half of the year. Hopefully the fading likelihood of a hard Brexit and a friendlier rhetoric between the US and China will slowly shine through in the numbers – as they say confidence leaves on horseback but returns on foot.

But as Mario Draghi said in his parting press conference, risks remain skewed to the downside. A key risk which threatens to become reality in November, is that the US shifts its protectionist gaze to Europe. The trade relationship between the two allies already soured in October after a WTO ruling found the EU had unfairly subsidised Airbus. Subsequently, the US imposed tariffs on $7.5bn of EU imports. Now, with the US and China set to sign an interim deal, the eurozone may be the next target of US protectionism. Already, on November 13th, the verdict on whether the US will tax auto imports from the EU is due. If it goes ahead, this would mark a major escalation.

The ECB has already put a lot of chips on the table to counter the eurozone slowdown and its decision to embark on new easing has been justified by the poor data ever since. If the downside risks materialise, Draghi’s successor, Christine Lagarde, will have to get innovative with monetary policy, or else, use her political acumen to persuade governments to crack open the fiscal coffers.

Author: Group Investment Office