Q2 Outlook: A reality check for the euro area
Video length: 2 minutes

Q2 Outlook: A reality check for the euro area

Christopher Dembik
Head of Macroeconomic Research

Summary:  The problems facing the Eurozone economy are neatly illustrated by fresh German data showing soft exports and contracting factory orders. While Chinese fiscal stimulus should help get Europe’s biggest economy back on track, expansionary fiscal policy across the bloc, as well as interest rate normalisation, are also necessary to ameliorate the ills of the euro area as a whole.

There is no such thing as global decoupling. Unsurprisingly, headwinds from China’s slowdown are starting to hit Europe and the US. The Organisation for Economic Co-operation and Development’s euro area leading indicator, which is widely used by asset allocators globally, has fallen sharply over the past few months. The year-on-year rate stands at its lowest level since the end of 2012.

At the same time, large declines in core European industrial production data can be observed, especially in Germany, which accounts for one-third of European industrial activity. This slowdown came as a shock for many policymakers, but we feel that it was predictable. Over recent quarters, our leading indicators (notably credit impulse) led us to warn clients and investors against the risk of lower growth in Europe.

Low credit impulse and China

The euro area faces two main issues: low credit impulse and the Chinese slowdown. The euro area credit impulse, a key driver of economic activity, is running at 0.4% of GDP, which is rather low compared with its four-year average of 0.8%. A country-by-country analysis shows that the risk of growth decoupling between core countries and the periphery of the euro area is emerging again. In France and Germany, credit impulse is positive, at 1.7% and 0.6% of GDP respectively. By contrast, the credit impulse is sharply decelerating in the periphery; it was close to zero in Q4‘18 in Italy and sits at -2.1% of GDP in Spain, a level not seen since the end of 2013.

This tends to indicate that a more restrictive credit cycle, especially in the periphery, has started. This will have a negative impact on domestic demand as it is highly correlated to the flow of new credit in the economy, and ultimately on growth as well.
Source: MacroBond and Saxo Bank
On the top of that, the euro area, which has been more and more reliant on Asian growth since the financial crisis, is hit hard by low economic activity in China. The two charts below show the drop in Germany’s export data; trade, which accounts for 46% of the country’s GDP, looks soft. Germany’s factory orders, at constant prices, are in contraction and close to their 2012 nadir. In other words, we are looking at a decline in the manufacturing sector months ahead as well as weak sentiment in the automotive industry. Digging further into the data, the most striking chart is German export growth to China, which has fallen sharply since the beginning of 2018 and is now in contraction as well.
Source: MacroBond and Saxo Bank
Source: MacroBond and Saxo Bank
The bright side is that China has opened the credit tap again, starting in the spring of 2018. We expect Chinese economic stabilisation by Q3 and a positive impact to Europe by Q4’19-Q1’20. Meanwhile, domestic measures to stimulate the economy need to be taken at the European level.

Monetary policy options

As it is so often the case, all eyes are on the European Central Bank. In a bid to win time and avoid a tightening squeeze hitting Eurozone banks, March saw the ECB announce a new round of TLTRO and a modification of forward guidance to extend its first rate hike into 2020. In our view, this is only a first step towards a more accommodative stance. As of today, discussions among ECB watchers are notably evolving around the idea of pushing the repo rate back to zero. The rationale behind this idea is that the benefit of negative rates is rather low; they are essentially a tax on banks that tends to further enfeeble the weakest banks. So far, the positive impact has been limited and has strongly depended on the structure of banks. The normalisation of the repo rate would be an easy move to reduce pressure on the banking sector if the risk of a tightening squeeze appears again.

Fiscal push in H2'19

These measures alone will not be enough to stimulate growth. They may help to push the credit impulse higher but other measures to support demand are also required. As economic data will continue to disappoint in the coming months, we believe that a new consensus for looser fiscal policy will emerge in European countries in H2’19. An accumulation of negative German data could be the perfect trigger to set off expansionary fiscal policy in Europe. If fiscal expansion is equivalent to 1% of GDP in Germany, it could lead to an average increase in the output of other European countries by 0.15% after two years, with the strongest impact on small, open economies sharing a land border with Germany to be around 0.4% according to Beetsma, Giuliodori and Klaassen1. Though the spillover effect of fiscal expansion usually tends to be small, it is largely positive and, coupled with the ECB’s accommodative monetary policy and China’s credit impulse, could be the right answer to ongoing headwinds.


Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Business Hills Park – Building 4,
4th Floor, office 401, Dubai Hills Estate, P.O. Box 33641, Dubai, UAE

Contact Saxo

Select region


Trade responsibly
All trading carries risk. Read more. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more

Saxo Bank A/S is licensed by the Danish Financial Supervisory Authority and operates in the UAE under a representative office license issued by the Central bank of the UAE.

The content and material made available on this website and the linked sites are provided by Saxo Bank A/S. It is the sole responsibility of the recipient to ascertain the terms of and comply with any local laws or regulation to which they are subject.

The UAE Representative Office of Saxo Bank A/S markets the Saxo Bank A/S trading platform and the products offered by Saxo Bank A/S.