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The pick-up in Euro Area growth in Q2 is unambiguously welcome news, particularly in view of the positive mix of contributions from Core domestic demand and Peripheral net exports. However, the conditions for sustainable growth are some way off – much of the region remains in recession, while the headline improvement in Peripheral net trade is driven largely by a collapse in imports. And we are certainly a long way from calling an end to the Euro Area crisis, as the fundamental structural problems facing the Euro Area have not gone away.
Broad based gains encouraging, but weak undercurrents remain
After six consecutive quarters of contraction, the Euro Area economy recorded growth of 0.3% in Q2. The pick-up in growth was broad-based, with all countries for which data are available registering an improvement compared with the previous quarter.
While the data reveal broad-based momentum, caution is warranted. Although welcome news, it is of course hard to label a reduction in the rate at which GDP is falling across the Periphery a recovery in the absolute sense of the word. Greek GDP recorded a drop of 4.6% year on year, while Cyprus – where capital controls remain in place – registered a 1.4% quarter on quarter decline. That was better than the previous quarter’s figure, but offers little more than a glimmer of hope. And falling output is endemic not only in the Periphery; the Netherlands is undergoing its own recession, sparked by excessive household debt and a collapse in house prices.
Peripheral net trade picture masks an import collapse…
Crucially, a lasting recovery in the Periphery requires not only a progressively higher contribution to growth from net trade, but one that is of the right kind – in other words, built on rising exports rather than collapsing imports. Although data are patchy at this stage, they are more consistent with the latter than the former.
Italian monthly trade statistics recorded a fall in imports of 2.1% in Q2 and an increase in exports of just 0.4%. That pattern is not new. Over the two years to 2013 Q1, net exports from the Periphery added almost two percentage points to growth across the single currency bloc. However, the bulk of the net trade contribution reflected collapsing imports, with just one fifth coming from rising exports.
They say every cloud has a silver lining, and the prolonged period of fiscal austerity, together with the associated deflation of wages and prices, has at least produced a marked improvement in competitiveness across much of the Periphery, both in absolute terms and relative to Germany. IMF data based on relative unit labour costs, show significant declines in the real effective exchange rates of most Periphery nations. In Ireland, for example, the real effective exchange rate has fallen some 38% from its peak in 2008. Only Italy has suffered a decline in competitiveness since the global financial crisis hit. In turn, this has produced a decline in import penetration. Although imports are falling in part because of the weakness of domestic demand, in Greece and Spain at least the share of imports in domestic demand has started to decline, even against a backdrop of increasing specialisation, and greater world trade. Moreover, exports as a share of GDP have risen across the Periphery.
…while Core reflation remains elusive…
A healthy composition of Peripheral net exports is only one part of the equation. Much stronger demand from the Core, Germany in particular, is also required. The positive cyclical momentum in the Euro Area can only prove sustainable in the long term if there is a substantial internal rebalancing between the Core and the Periphery.
As the chart above shows, while the Peripheral nations have at least started to do their bit, with current account deficits narrowing substantially, and even moving into surplus in the case of Ireland, the German current account surplus remains stubbornly large. Germany continues to pursue growth through net trade rather than through domestic demand. The German consumer has proved extremely reluctant to spend. It is striking, for example, that the level of German retail sales is actually lower now than it was when the series was first produced back in 1994. And although the broader measure of household expenditure published in the National Accounts has shown positive growth over the period, the German household sector saving rate is unusually high among developed economies, at around 10%. Historically, the German household sector saving rate has tracked long-term interest rates closely, but that relationship has broken down during the past ten years or so. Savings remain stubbornly high in spite of low returns.
A return to growth across the single currency bloc as a whole is undoubtedly a welcome development. But if it is to last Germany must do her bit, and promote growth through internal rather than external demand. Of course, it may well be that the structural problems bedevilling the Euro Area are weighing down on confidence, and by extension expenditure, in the Core as well as the Periphery.
…and the Euro Area’s large structural problems persist
The structural impediments to Euro Area growth have not gone away. Rebalancing momentum remains weak and uneven, with deflation in the Periphery not being matched by reflation in the Core. In addition, the potential spill-overs from Fed tapering pose a threat to debt sustainability in the Periphery, while progress in private sector deleveraging has so far been limited. Nor are we getting anywhere close to a full banking union. We are a long way from calling an end to the Euro Area crisis.
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