Pantheon Macroeconomics - Will EZ services hold their own amid weakness in manufacturing?

News | Question of the Week, WC 6th Jan 2020
Will EZ services hold their own amid weakness in manufacturing?

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Question of the Week, WC 6th Jan 2020

Q: Will EZ services hold their own amid weakness in manufacturing?

A: The economic data at the end of 2019 could hardly have been clearer; the EZ economy is running on one engine in the form of a still robust services sector amid a sustained recession in manufacturing. The three charts below tell this story in a convincing fashion. The first two shows that the divergence between the services and manufacturing surveys is now wide as ever, while the third backs this up with a similar picture from the national accounts. 

The split between services and manufacturing alongside generally tepid GDP growth has tended to generate one central question from investors: Will services remain resilient in the face of weakness in manufacturing? Our answer is: Yes. Historically, the EZ economy has fallen into recession in periods when the economy is suffering from a simultaneous hit from external weakness in the global economy and 

 tightening domestic financial conditions. The latter is usually driven by higher interest rates, but pro-cyclical tightening in fiscal policy also has played a role, for example during the sovereign debt crisis in 2011 and 2012. At the moment, the EZ economy is certainly struggling under the weight of elevated external uncertainty and slower global growth, and weakness in its key manufacturing export sectors, especially autos. Domestic financial conditions, however, are loose as ever. Moreover, the current setup suggests that the more uncertain the external environment gets, the looser domestic policy will tend to be, a response which is currently available to policymakers due to absence of inflation and wage pressures, or at least, the downplaying of any such risks. This means that the current economic cycle in the EZ is slightly unusual. 

With this analytical backdrop, our baseline is that EZ GDP growth will turn a corner this year helped by sill-robust growth in the domestic economy and a gradually fading drag from slowing manufacturing—especially inventories—and falling net exports. Full-year growth estimates are hampered by a weak statistical carry-over effect, but we think the underlying run-rate in GDP growth will improve slowly, to around 0.3% quarter-on-quarter, from its current pace of 0.1-to-0.2%. That’s excellent news, though with respect to markets, it seems that even the most optimistic forecast already is priced-in, but that’s not unusual either.  

Claus Vistesen

Chief Eurozone Economist

Posted: 9th Jan 2020

Consistently Right

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