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Eurozone

by Dr. Alexander Boersch
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    4 minute read 12 August 2019

    Eurozone Showing economic resilience in the face of trade headwinds

    4 minute read 13 August 2019
    • Dr. Alexander Boersch Germany
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    • Diverging trends and moderate growth
    • The manufacturing recession
    • Can manufacturing and services decouple forever?

    ​Resilient domestic demand contrasts weaknesses in global trade. The eurozone, therefore, continues the recent trend that combines a resilient services sector with struggling manufacturing industries. The question is: how long can this divergence last?

    Diverging trends and moderate growth

    The slowdown in the eurozone continues with an estimated growth rate of 0.2 percent in the second quarter,1 after 0.4 percent growth in the first quarter. Among the big eurozone economies, Spain showed the highest quarterly growth rate, and business and consumer sentiment in France rebounded. Germany grew stronger than expected in the first quarter due to a rebound of car sales after the production delays at the end of 2018, while the Italian economy has largely stagnated.2

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    A very positive trend cutting across the eurozone relates to labor market performance—employment in the eurozone continues to grow. Currently, there are 159.5 million people employed in the eurozone—the highest level ever recorded. The number of persons employed has increased by 10.8 million in the euro area since 2013Q2.3 The unemployment rate was down to 7.5 percent in June, almost one percentage point less than a year before, and the lowest since July 2008.4

    The strength of the labor market is matched with renewed wage-growth dynamics. While wages grew slowly for a long time, they are now picking up momentum and are growing at the strongest pace since 2011.5 Combined with still-low inflation, this should continue to support private consumption in the coming quarters (figure 1).

    Wage and inflation dynamics support private consumption

    Powered by robust private demand, the services sector shows strong resilience and currently acts as the growth engine in the eurozone. Nonetheless, the industry sector remains weak, with industrial output being on a decline since early 2018 (figure 2). Therefore, the diverging trend of resilient services and a struggling industry sector continues in the eurozone.

    Divergence between industry and services continues

    The manufacturing recession

    The overall weakness in manufacturing affects particularly the manufacturing-intensive economies of Germany and Italy. Industrial output in Germany and Italy has been on a broad downward trend since the middle of last year. A contributing factor to this parallel development could be the close integration of German and Italian industrial supply chains and their higher exposure to developments in the United States and China.6

    Industrial output in France and Spain has not grown much either, but it shows a slightly positive trend over the same period (figure 3).

    The manufacturing sector in Germany and Italy is strained

    While strong domestic demand supports the services sector, it is investment and exports that usually drive the manufacturing sector. A deeper look at the key destination countries for the eurozone’s exports reveals that exports to the United States and China have stagnated since late 2018. Surprisingly, exports to the United Kingdom saw a sharp rise in the first quarter of 2019 (figure 4). However, this was probably due to temporary stockpiling in the United Kingdom in anticipation of the original Brexit deadline in late March. Without this temporary effect, exports to the eurozone’s major markets would have remained flat.

    Exports had a net positive contribution in Q1 mainly due to stockpiling in the United Kingdom in anticipation of Brexit in March

    Without a rebound in world trade, exports alone will not to be able to drive manufacturing output and, therefore, growth in the eurozone. Current data and projections do not suggest a trade recovery any time soon. According to the World Bank, global trade growth will fall from 4.1 percent last year to 2.6 percent this year; the weakness in trade so far has affected mainly capital goods.7

    Additionally, many corporates show a decreasing appetite for investment. While investment in construction is strong, that in equipment and machinery is growing considerably weaker than last year.8 In this sense, growth impulses for manufacturing from exports and investment remain weak at best.

    Can manufacturing and services decouple forever?

    The divergence between manufacturing and services seen currently is surprising. While the two sectors are usually driven by different kinds of expenditure, several service sector outputs are inputs into manufacturing; in other words, there is a spillover effect from manufacturing to services. However, in recent years, the correlation between the two industries has declined in almost all major economies.9

    The reasons are manifold, but one key factor that impedes the spillover effects involves labor market trends. In almost all major industrialized countries labor markets are very tight. According to Deloitte’s European CFO Survey Spring 2019, labor shortage is one of the main risks for European companies; in Germany, the Netherlands, and Austria, they are the most important risk.10

    In this situation, companies tend to hire or keep more employees than they usually would to protect themselves from the adverse effects of labor shortages.11 This employment security, however, comes possibly at the expense of productivity growth.12 Coupled with employment increases, especially in knowledge-intensive services, which are relatively immune to cyclical trends, the services sectors were likely able to increase their resilience.

    As for the economic outlook in the coming next quarters, this implies that any positive or negative change in the labor market and private consumption could directly affect growth in the eurozone.

    Acknowledgments

    Cover image by: Tushar Barman

    Endnotes
      1. Eurostat, “GDP up by 0.2% in both euro area and EU28,” press release, July 31, 2019. View in article

      2. Eurostat, “GDP up by 0.4% and employment up by 0.3% in the euro area,” press release, June 6, 2019. View in article

      3. Ibid. View in article

      4. Eurostat, “Euro area unemployment at 7.5%,” press release, July 1, 2019. View in article

      5. European Central Bank, “European Central Bank—Statistical Data Warehouse—quick view" and "Compensation per employee,” accessed July 17, 2019. View in article

      6. Raju Huidrom et al., Trade tensions, global value chains, and spillovers: Insights for Europe, International Monetary Fund, June 12, 2019. View in article

      7. World Bank, Global Economic Prospects (Washington, DC: World Bank, 2019). View in article

      8. Eurostat, “Gross fixed capital formation with asset breakdowns,” accessed 2019. View in article

      9. Laurence Boone, “OECD Economic Outlook May 2019,” OECD iLibrary, accessed August 3, 2019. View in article

      10. Deloitte, European CFO Survey: Eyes on demand, accessed August 3, 2019. View in article

      11. Ifo Institute, “ifo Economic Forecast Summer 2019: ifo Institute affirms 0.6 percent growth in 2019,” June 18, 2019. View in article

      12. European Central Bank, “Eurosystem staff macroeconomic projections for the euro area, June 2019,” June 6, 2019. View in article

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    Topics in this article

    Economics , Eurozone , Europe Middle East Africa (EMEA) Economics , Europe Middle East Africa (EMEA)

    Deloitte Global Economist Network

    The Deloitte Global Economist Network is a diverse group of economists that produce relevant, interesting and thought-provoking content for external and internal audiences. The Network’s industry and economics expertise allows us to bring sophisticated analysis to complex industry-based questions. Publications range from in-depth reports and thought leadership examining critical issues to executive briefs aimed at keeping Deloitte’s top management and partners abreast of topical issues.

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    • Alexander Börsch
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    • aboersch@deloitte.de
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    Dr. Alexander Boersch

    Dr. Alexander Boersch

    Director | Deloitte & Touche GmbH

    Alexander is the chief economist and head of research for Deloitte Germany. His expertise lies in the analysis of economic trends and their impact on companies and the business environment. He is the author of numerous publications on German and European economics, Brexit, trends in the digital economy and globalisation. Prior to joining Deloitte, Alexander was Senior Economist at Allianz Global Investors.

    • aboersch@deloitte.de
    • +49 (0) 89290368689

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