The Eu­ro­zone funk deep­ens

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

Europe’s po­lit­i­cal lead­ers may be talk­ing about fresh sanc­tions on Moscow, but the con­ti­nent’s re­main­ing eco­nomic op­ti­mists are fast ca­pit­u­lat­ing in the face of Rus­sian ag­gres­sion in east­ern Ukraine. Both the Euro­pean Com­mis­sion’s eu­ro­zone eco­nomic con­fi­dence survey and the INSEE French business con­fi­dence survey, re­leased late last week, de­te­ri­o­rated in Au­gust, with the EC survey slump­ing to its gloomi­est read­ing this year. This de­cline in sen­ti­ment re­verses a di­ver­gence be­tween soft­en­ing ‘hard data’ and survey re­sults that un­til re­cently were rel­a­tively up­beat. How­ever, in­stead of the hard data grind­ing higher as the op­ti­mists had hoped, the sur­veys have slumped lower. It is now ob­vi­ous that the eu­ro­zone has got it­self into a ver­i­ta­ble eco­nomic funk. Be­hind this funk is a confluence of forces in­clud­ing: · The weak­ness of the yen over the past 18 months. A weak euro-yen ex­change rate long helped keep the wind in the sails of Europe’s ex­ports to emerg­ing mar­kets. How­ever, as the yen weak­ened the eu­ro­zone’s ex­ports to emerg­ing mar­kets be­gan to strug­gle. Take Ger­many as an ex­am­ple: while ex­ports to China con­tinue to make new highs (at EUR 19bn a quar­ter), quar­terly ex­ports to other BRIICS mar­kets have dropped from EUR 18bn to 15bn. · The im­pact of Rus­sian

sanc­tions. Even

be­fore Moscow adopted an openly con­fronta­tional stance over Ukraine, Rus­sian growth had de­cel­er­ated from 5% year-on-year in 2012 to just 0.7% in the first quar­ter of this year. This is alarm­ing, es­pe­cially as the oil price re­mains rel­a­tively el­e­vated, and em­pha­sises how hopes that Rus­sia’s WTO ac­ces­sion would prove a new lo­co­mo­tive for eu­ro­zone growth need to be re­vised. To be sure, sanc­tions will hurt Rus­sia a lot more than Europe. Last year, Rus­sian busi­nesses en­joyed some $194bn of for­eign di­rect in­vest­ment in­flows, 75% of which came from the EU. This will now slow to a trickle (as will trans­fers of pro­duc­tiv­ity-en­hanc­ing man­age­ment ex­per­tise and tech­nolo­gies). Mean­while, on the EU side of the equa­tion, the 29% ap­pre­ci­a­tion of the euro against the ru­ble since March 2013 had al­ready con­trib­uted to a 20% fall in ex­ports to Rus­sia even be­fore the first round of sanc­tions was an­nounced at the end of July. As a re­sult nearly 0.1% was shaved off nom­i­nal GDP growth over the last year, an amount that is bound to rise as sanc­tions kick in.

Of course, the good news is that the euro is now fall­ing, which should help ex­ports. Plus, ex­ports to Rus­sia only ac­count for 2.7% of the eu­ro­zone’s to­tal (down from 3.4% a year ago). How­ever, with most Euro­pean coun­tries ei­ther al­ready in re­ces­sion (Italy) or flirt­ing with one (Ger­many and France) even a small blow could be enough to in­jure an­i­mal spir­its in an al­ready de­pressed eu­ro­zone.

This brings us to one of the more sig­nif­i­cant sto­ries of the last few days: the news that the ECB has hired Black­rock to de­vise a pro­gramme of as­set-backed se­cu­ri­ties pur­chases. After months in which the ECB in­sisted it was ‘mon­i­tor­ing the data and ready to act’, this news can only be seen as a dis­ap­point­ment. After all the data has been ter­ri­ble for months, but it turns out that ‘ready to act’ ac­tu­ally meant ‘ready to hire an ad­vi­sor who will then help us de­vise a plan so we can trans­form words into ac­tions’. Why wasn’t Black­rock hired three, or even six, months ago? And how come the 2,000 or so staff mem­bers who toil in Frankfurt, along with the thou­sands more at the Banque de France, the Bun­des­bank, the Bank of Italy, etc., can’t man­age to put to­gether an ABS pur­chase plan by them­selves?

At this stage, it is ob­vi­ous that most Euro­pean coun­tries (not least Italy and France) need tax cuts fi­nanced in part by a more ex­pan­sion­ary mon­e­tary pol­icy. How­ever, after six months in power Ital­ian prime min­is­ter Mat­teo Renzi is more fo­cused on po­lit­i­cal re­form than fis­cal change, while in France the re­cent gov­ern­ment reshuf­fle seems to high­light that the EUR 40bn in cor­po­rate tax cuts an­nounced six months ago is likely to be as good as it gets for the next bud­get (though the ar­rival of the ‘sup­ply-sider’ Em­manuel Macron as econ­omy min­is­ter is an en­cour­ag­ing sign that more la­bor mar­ket re­forms may yet hap­pen). Mean­while, the ECB is still ‘study­ing its op­tions’, rather than tak­ing ac­tion. Putting it all to­gether, we have to con­clude that the path of least re­sis­tance is for Europe to con­tinue de­te­ri­o­rat­ing and that no ma­jor pol­icy ini­tia­tives will be taken over the next cou­ple of months. This will re­in­force the grow­ing in­vestor per­cep­tion that Europe should be a source of, rather than a des­ti­na­tion for, cap­i­tal.

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