Upgrading German and European growth
One thing to keep in mind regarding both politics and shares in Europe is that upgrades to the growth outlook are coming and more should be expected. I see Germany doing particularly well given the decline in the euro. This is positive for shares but negative for Greece. Some thoughts below
I decided last night to write this post. And coincidentally, just this morning, I saw that UBS was upgrading its growth forecasts for Europe to 1.6% in 2015 and 2.0% in 2016. I have been saying for the past three months that we should expect this despite the malaise in Europe. As I put it in early December, “the decline in oil prices is, on net just a shift from oil producers to oil consumers. From a global perspective, we will see the uptick in consumption associated with that shift first. Only later will do we see the full downshift in consumption amongst producers. For example, the Saudis are still well above production cost at these levels. That means their only constraint is macro and fiscal. To the degree they are willing to tough this period out and dip into foreign reserves, we may see negligible cutback in demand from Saudi Arabia or Russia, which is in a similar position. Mexico says it has hedged a huge slug of its production. So there again, we cannot expect immediate cutbacks. It’s with the states in more precarious fiscal and external balance positions like Venezuela or Libya that we have to worry. And there the concern is more geopolitical than economic because these countries make up so little of the global economy. What I am saying is that high oil prices are like a regressive tax that hurts those with the greatest marginal propensity to spend the most while it hurts those with the lowest consumption demand elasticity the least. On net, lower oil prices are positive for growth.”
I also concluded in December that Europe would be a net beneficiary given its dependence on energy imports. “Europe will gain a lot from the decline in oil prices without much in the way of oil industry drags on growth. My baseline for Europe is now increasing. Absent exogenous shocks for a stall-speed Europe, watch for growth above expectations in Q4 and Q1 2015.”
This is exactly what has transpired. And now that we are into the end of Q1 2015 we can see the upgrades to growth are going to continue. This is a big benefit for European asset markets. With the ECB engaged in quantitative easing, we should also see an additional lift due to the backstop this provides to periphery countries, eliminating tail risk associated with the turmoil going on in Greece. But quantitative easing has at best derivative impacts on the real economy. If I had to take a more aggressive ideological stance I would say what I said in late January, that “quantitative easing and negative interest rates will fail”. And by that I mean that over the medium-term, inflation and nominal GDP will fall until wages rise or debts fall relative to wages. What we are seeing now is purely cyclical unless and until we see a pass-through to wages and the real economy.
Think of QE as a stepping stone to longer-term growth strategies, something that buys time and lifts asset prices, nothing more. But of course, negative rates and QE are making European fixed income assets less attractive on a relative basis. That has portfolio balance effects which is depressing the value of the Euro. Germany benefits the most from this because of its large current account surplus both as a percentage of GDP and in absolute terms. Upgrades to German growth should continue then. The Bundesbank knows this too. In December I pointed to Weidmann’s comments on that score despite 2014 growth estimates being cut. I wrote that, “even though we are seeing downward revisions for Europe and Germany right now, those numbers were well known. Bundesbank head Weidmann has acknowledged that if oil prices stay at these levels, there will be a boost that means 2015 GDP projections will have to increase from the present low levels.”
The question then becomes, given German concern with being a fiscally prudent role model and reducing its government debt burden in order to get back toward the Maastricht 60% hurdle, how much additional stimulus can Germany muster to spread the wealth. I think this is the great unknown right now. I do expect some movement on infrastructure srtimulus that should provide an additional small boost for Europe.
But for Greece, the growth dividend in Europe is actually bad news. It isolates Greece as a separate case and helps the case of those who would like to make an example out of Greece in order to prevent parties like Podemos from coming to power in Spain.
I don’t want to end on that note, however. Despite my ‘ideological’ belief that quantitative easing and negative interest rates will fail, I do see these policies as having portfolio balance impacts which, combined with the real economy impact of lower oil prices and economic basing in the eurozone, will boost eurozone GDP and asset markets for the foreseeable future. This would be a good time to make the institutional arrangements necessary to deal with the next cyclical downturn. Whatever you make of the political constraints and the long-term outlook in Europe, the near-term is looking up.