Broken Europe Broken Europe Broken Europe

Broken Europe

Christopher Dembik

Head of Macroeconomic Research

Summary:  While the economic situation in Europe may not be as bad as feared, there's still a plethora of things to fix.


A resilient economy

We were too pessimistic about the euro area. Softer energy prices, the lack of black-out (resulting both from energy supply diversification and better weather conditions) and resilient hard data (notably in Germany) are pushing forecasters to review their 2023 recession calls. The eurozone 2023 consensus GDP is up from minus 0.1 percent to 0.0 percent. This is a small but significant move and it doesn’t appear to be the end. We still believe the consensus is too low. In mid-January, Goldman Sachs was the first international bank to completely reverse its call for the eurozone, moving its GDP growth forecast from minus 0.1 percent to 0.6 percent. We are not that bullish at Saxo but we confidently believe that the eurozone could avoid a recession this year with a GDP growth target close to 0.3 to 0.4 percent. Remember that a few months ago, approximately more than 90 percent of the forecasters predicted that a recession is the baseline for this year. 

What has changed? The economy is actually stronger than expected. The Citi Economic Surprise Index (below chart) now stands at a one-year high. This means that economic data are better than economists’ projections. This may especially be true for Germany. While gas consumption has collapsed by double digits, industry output has remained largely flat. Not only could this be considered as a remarkable achievement, based on the latest November data on industrial production, but it also looks like there may be no recession in the German industry in Q4. The first estimate of German 2022 GDP is also significantly higher than forecasted, at 1.9 percent – this represents 0.5 points above the government’s target. Everything indicates that the economy will remain at a resilient pace in the short term, with all the nowcasting models pointing to an economic recovery this quarter. Hence, the probability of a recession is now declining quite fast. We also believe there will be no extreme macro and market events in 2023 – which could be positive from a growth perspective. If the economy performs much better, this will however give ECB policymakers more confidence in hiking rates as laid out in December by Christine Lagarde.

Economic surprises are improving significantly in the euro area. The consensus, 0.0 percent GDP growth in 2023, seems slightly conservative and is bound to be revised up.

But risks are looming

However, this does not mean that the year 2023 will not be challenging:

  • Credit stress is on the rise – this is the first time in a decade we start the year with European IG credit yield above the 4 percent level. Expect many companies to face difficulties getting access to new sources of funding. Many small and medium caps will probably have no other choice but to resort to ultra-dilutive financing, such as convertible bonds. Retail investors should stay away from these listed companies.
  • The market will need to absorb about €700bn of liquidity due to the ECB quantitative tightening. This is a complicated exercise which will result in tighter financial conditions and perhaps higher volatility in equity.
  • The energy crisis will be back on the agenda again. This is not politically correct, but climate change has certainly helped avoid an energy crisis in Europe so far. However, when it will be time to refill depleted stockpiles in the spring, expect that prices will move up again. We are confident that the EU will be able to find energy suppliers (for instance, natural liquified gas from the United States, Australia or even Mozambique), but at a high cost. This will ultimately fuel inflation higher in the second semester, along with higher oil prices resulting from higher Chinese demand (we estimate that China’s reopening will boost oil demand by 4m bpd around spring – this is about three times more than the growth in demand forecasted by the market).
Prices on the wholesale electricity market increased tenfold during the peak of the 2022 crisis in several EU countries. This was partially explained by rising gas prices due to the war in Ukraine and problems with nuclear generation in France. Now, prices are receding. But the market does not expect a return to the pre-Covid situation (where prices were below EUR60 per MWh).

What about the risk of a wage-price spiral?

The labour market remains tight in the eurozone. The last data show that the eurozone unemployment was at 6.5 percent in November 2022 and at 6.0 percent in the European Union. Within the EU, Spain scores the highest official unemployment rate (12.4 percent) and Germany and Poland the lowest one (3.0 percent). In a working paper published in mid-January, ECB economists pointed out the risk of high wage growth in the coming quarters – way above historical patterns: “This reflects robust labour markets that so far have not been substantially affected by the slowing of the economy, increases in national minimum wages and some catch-up between wages and high rates of inflation.” We tend to disagree with this assessment. Wage growth is of course fuelling inflation in the CEE area, but this is clearly not the case in Western Europe. The likelihood that wages will increase significantly, thus becoming an issue in regards to the fight against inflation, is rather low in our view. Actually, in several countries, wage increases are dramatically lagging behind inflation. In Spain, the average real wage is now below what it was 15 years ago! It is hard to think there will be a wage-price spiral. However, if the ECB believes this is a material risk, they could decide to tighten too much – thus increasing credit stress.

Overall, we believe the consensus was and is still too pessimistic about the eurozone 2023 GDP growth. There is a high probability that a recession will be avoided. That being said, Europe is still broken. The energy crisis remains a major risk for the next winter – with the EU being still reluctant to embrace nuclear energy and being unable to move fast on the project of a reform of the electricity market. While the ECB expects wages to increase substantially, we see that workers are in fact becoming poorer in most countries. Several companies which have benefited from the abnormal negative interest rate periods will now face a moment of truth – many of them will probably go bankrupt. Politically, we are not optimistic. EU presidencies offer little ambition – Sweden, which heads the Council of EU unsurprisingly focuses on the Ukraine war while the Spanish presidency in the second half of 2023 will be dominated by elections in the country. There is not much positive to expect from politics this year.

Disclaimer

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000
Australia

Contact Saxo

Select region

Australia
Australia

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.