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- Friday's data means "German recession all but confirmed"
- Data comes days ahead of ECB meeting, stimulus seen as likely.
- Prospect of action may condemn EUR to losses in week ahead.
The Euro fell from recent highs against major rivals after data from Germany confirmed a trend of deteriorating growth remains intact, which will only add to expectations the European Central Bank will this month announce a series of measures to underpin the floundering Eurozone economy which could in turn work to keep a lid on any excesses in the single-currency.
German industrial production fell by 0.6% in July, according to Destatis figures released Friday, when markets had been looking for a 0.4% increase to draw a line under the previous month's -1.5% contraction. The disappointment means the industrial sector got off to a torrid start in a quarter where the German economy must grow in order for it to avoid a so-called 'technical recession' that is defined as two consecutive quarters of contraction.
"A much worse headline for industrial output than we had expected, even with the upward revision to the June numbers," says Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics. "The July industrial production headline combined with the dreadful retail sales number now send a convincing signal that the German economy is in recession. The August and September numbers could still spring upside surprises, but we don’t have high hopes."
Above: Pantheon Macroeconomics graph of manufacturing orders (PMI) correlation with output.
Germany's economy, the growth engine of the Eurozone if not the European continent, has gone into a tailspin in 2019 due to an ongoing downturn in the manufacturing sector. German industry does a large trade with China and its car firms bet big on the Chinese market for luxury vehicles in recent years due to the country's burgeoning middle class, but all of that has changed with the outbreak and each escalation of the trade war with the U.S.
China's economy has struggled as a result of the trade war and officials have felt compelled to provide monetary and fiscal stimulus to it on multiple occasions in the last year, although that's not stopped demand for German manufactured goods from ebbing. That saw the economy contract by 0.2% in the second quarter and many are now increasingly attuned to the threat of a recession.
The numbers will only add pressures on the ECB to announce a 'shock and awe' set of measures at their September meeting, designed to stimulate economic growth and boost inflation.
"With euro area growth and inflation remaining depressed, Mario Draghi is likely to announce a significant easing package when the ECB Governing Council meets next week. Loose monetary and financial conditions should keep the risk of a region-wide recession low. But the economy is unlikely to rebound meaningfully as long as governments shy away from boosting spending," says Karsten Junius, chief economist at J.Safra Sarasin, a Swiss private bank.
Above: J Safra Sarasin Eurozone growth estimate (left) and subjective recession probability.
The Euro tends to underperform and trade below 'fair value' levels at times of ECB stimulus, as the policies incentivise the export of cheap-to-borrow Euros out of the Eurozone, while providing little attraction for foreign investors to pump their capital into Eurozone money assets owing to the poor returns on offer. Quantitative easing - also known as the asset purchase programme - meanwhile increases the supply of Euros into the economy, thereby diluting unit value.
Economic headwinds are intensifying in the Euro area at a time when inflation has been below the ECB target of "close to, but below 2%" for years, and at a point when the Eurozone growth pulse was already insufficient for generating a sustainable increase price pressures. This is why markets now expect the ECB to take action on Thursday, 12 September.
Weakness in the German economy has helped drag the rate of Eurozone GDP growth lower, from 0.4% to 0.2% in the second quarter. However, it's not the continent's only ailment because the domestic side of the Eurozone economy also weakened in some parts during the recent quarter, according to the first detailed breakdown of GDP figures released by Eurostat on Friday.
"A slowdown in consumers’ spending and public consumption growth were among the primary drivers of the dip in EZ GDP growth in Q2. Investment growth accelerated, though the Q1 number was revised down sharply, shifting base effects. Inventories were flat, rebounding from a sharp 0.2pp drag on the quarter-on-quarter rate in Q1, while net exports were a 0.1pp drag, partly reversing the 0.2pp boost in Q1," says Pantheon's Vistesen.
Above: Euro-to-Dollar rate shown at daily intervals.
Markets now expect the ECB to cut at least one of its interest rates as a minimum net week, but many also increasingly forecast it will restart the quantitative easing program that it only just wound up back in December 2018. Changes in interest rates are normally only made in response to movements in inflation, which is sensitive to growth, but impact currencies because of the push and pull influence they have over capital flows.
A QE program would see the ECB buy European government and corporate bonds, forcing down yields (borrowing costs) in the process. Such a program would be billed as enhancing or otherwise quickening the transmission of lower borrowing costs into the real economy. However, an adverse side effect of this for the Euro is that it will mean investor returns from owning the single currency will fall even further, potentially leading some of them to sell it next week.
"EUR/USD has seen a strong bounce from its current September low at 1.0926. Nearby resistance can be found at the April and May lows at 1.1110/1.1106 as well as along the three month resistance line at 1.1132. Only a daily chart close above the August 26 high at 1.1164 would confirm a bottoming formation and put the 200 day ma at 1.1268 back on the cards," says Axel Rudolph, a technical analyst at Commerzbank.
Above: Euro-to-Dollar rate shown at hourly intervals.
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