Euro zone: Consumers are key to avoiding recession

News that Germany’s economy shrank 0.1% in Q2 (q/q) sent a shudder through markets last week, heightening fears of global recession. The euro zone as a whole stayed in positive territory but GDP growth slowed to 0.2% from 0.4% in Q1. Germany depends heavily on exports sothe weakness in China as well as the trade war, which also hangs over Europe, is hitting Germany particularly hard. The good news, and what should keep the euro zone growing, is that consumers in Europe are generally in good shape. Unemployment continues to fall, wage growth has picked up and consumer confidence is high.

Germany’s dependence on manufacturing exports makes it highly sensitive to China’s economy. As I have highlighted in recent months, the authorities in China have so far been unable to reverse China’s 2018 economic slowdown despite significant tax cuts and monetary easing. It looks as though they are still pulling their punches – more on this in a future post – though China’s recovery is also hampered by the US-China trade war.

For Germany it is not just about China. Business investment is held back also by worries over Brexit and the potential that President Trump will turn his attention to Europe before long. Meanwhile the car industry is going through a tough time. Pent up demand for cars from the last recession is pretty much dissipated now while the abrupt switch away from diesel is causing problems. Germany’s economy looks set to remain sluggish at best, though a full recession still looks unlikely, as long as consumers keep spending.

Weak Germany growth might at least make it easier for ECB President Draghi to deliver some more stimulus at the September meeting. But monetary conditions are already very easy, especially after bond yield declines in recent weeks, so the important thing for monetary policy is to make sure banks keep lending.

Dependence on consumers is not just a euro zone story. It is true too of the US, UK and even China. Business investment is weak globally for two reasons. One is that there has been plenty of investment in recent years, so there is little pent-up demand to do more. This is particularly true of China, of course, which is coming off a twenty-year investment boom. It is also true of the US, where despite worries that investment is weak, it has actually been reasonably solid in real terms in the last 10 years.

The second big factor is uncertainty - over trade wars, the China slowdown and Brexit. Goldman Sachs recently increased its estimate for the economic cost of Trump’s trade war. Previously they had used the direct impact of tariffs as a guide, which suggested the effects are fairly small. Now they are factoring in a much bigger effect from uncertainty. It is not just Trump’s policies but his unpredictability that is causing problems. That unpredictability is likely not just a symptom of a short attention span or inconsistent policy-making. It is probably deliberate. Unpredictability keeps your opponents guessing and adds to the news value. The question is whether consumers will notice all this, and begin to pull back too. My guess is that they won’t and that worries about a European, US or world recession will prove premature. But keep watching consumer confidence.