Eurozone Checkup

I have already pointed out how 2006 despite a relative slowdown in the two last quarters was going to be a record year in terms of annual growth rates. Today, the numbers on Germany, the zone's biggest economy, are out showing an impressive 2.7% expansion which is the highest since 2000 (The FT). Interestingly enough, the FT article emphazises the outstanding year in Germany as one driven by domestic consumption.

German consumers’ reluctance to spend was finally smashed last year, the country’s statistical office declared on Thursday as it reported the strongest year of economic growth since 2000.

Consumer spending reversed the trend of recent years to outpace growth in disposable incomes, according to Walter Radermacher, president of the federal statistics office. “The reluctance to spend by private households, which has acted as a brake on growth since 2001, appears broken through,” he said.


Despite the renaissance of its industrial sector, consumer spending has remained the country’s Achilles’ heel. However, private consumer spending rose by 2.0 per cent last year, before adjusting for price changes, compared with a 1.7 per cent increase in disposable incomes. The proportion of incomes saved fell slightly, although at 10.6 per cent, remained high.

At constant prices, German consumer spending rose by 0.6 per cent last year. That may have been modest in comparison with other large industrial countries. But it marked a turnaround by German standards after three years in which consumer spending had remained flat.

Nevertheless, some scepticism about the strength of consumer spending is likely to remain; November’s retail sales figures – the latest available - showed a fall compared with the previous month, and spending late last year might have been distorted as Germans brought forward purchases to avoid a three percentage point rise in VAT at the start of this month.

I am not sure I agree here and, at least, I believe that we need to emphasize that the German growth rate in 2006 also to a large extent was driven by a significant boost in exports.

Growth in Germany's economy, Europe's largest, last year accelerated to the fastest pace since 2000 as companies boosted spending and hiring to meet orders. 


German companies have stepped up spending and hiring to meet increasing export demand, boosting consumer optimism. The trade surplus rose to a record in November and industrial production increased the most in seven months. Unemployment fell in December by the most since reunification in 1990 to a rate of 9.8 percent.

So it would be vastly overstated to claim that 2006 was predominantly a consumption driven growth story in Germany. We should also note the FT article's point about how in fact German consumer spending is significantly lower than in other industrial countries and also lower than the Eurozone average. The following graph which was circulated to me in a mail from Sebastian Dullien at Eurozone Watch shows this.











This simply means that we need to put this in perspective in terms of a year in Germany where growth has been, after all, very impressive and thus above what we can expect going forward. Of course the much illusive VAT tax hike is also important to note here but it is decisively difficult to say just how big a dent it will (if any?) have on consumer spending as we move forward in 2007.

Meanwhile, another sublte yet important point about growth in the Eurozone this year comes from studying the quarterly growth figures; the FT piece linked above points this out nicely ...

Overall, German GDP rose by 2.7 per cent last year, after taking into account differences in the number of working days.

GDP probably grew by about 0.5 per cent in the final quarter of last year, the statistics office, estimated, roughly in line with the 0.6 per cent growth seen in the third quarter. However the third and fourth quarters figures were lower the 0.8 per cent and 1.1 per cent seen in the first two quarters of the year.

Consequently, the Q3 and Q4 show a significant lower pace than the two first quarters of 2006 which, at least to some extent, should hint that the business cycle might have turned some time ago earlier last year. How far we will venture downwards is of course still an open questions and as such this should not be worrying in itself.

Meanwhile, there are other economies in the Eurozone than Germany and for example France where growth oddly stalled in Q3 of 2006 continues to send out ill signals.

French industrial production unexpectedly fell in November as car output slumped.

Production at factories, utilities and mines fell 0.2 percent from October, when it stagnated, Insee, the national statistics office, said today in Paris. Economists expected a gain of 0.7 percent, according to the median of 22 forecasts in a Bloomberg News survey. Output of cars slipped 3.2 percent.

The decline suggests Europe's third-largest economy may not have grown as much as expected by the government in the last three months of 2006 after failing to expand in the third quarter. Companies may struggle to step up production as global demand slows and tax increases in Germany hamper France's biggest trading partner.

It is still difficult to say what the final dent in annualized growth figures will be but where economists before Q3 were expecting a growth rate in the line of Germany's (i.e. a 2.5% range) we are probably now closer to 2%. This will also likely put a small black spot on the total Eurozone growth rate in 2006. Finishing off with central bank decisions the ECB chose to hold at 3.75% 3.5%  but the real important point comes in February which will show whether the ECB in fact has marked 2007 as the year for normalization of interest rates. Moving across the channel (and out of the Eurozone) to the UK the Bank of England chose to increase the rate for the third time since August 2006 on inflation worries. Currently the inflation rate is running at 2.7% in the UK which is well above the rate in the Eurozone which oscilliates between 1.8% and 1.9%. However, in a general sense the UK situation is a bit like in Denmark and as such the BOE is presumably acting preemptively gainst the fear of wage demands in the 'January job round.'

The Bank of England unexpectedly raised its benchmark interest rate by a quarter-point, the third increase since August, saying inflation may accelerate and spur demands for higher wages.

The nine-member Monetary Policy Committee lifted the repurchase rate to a five-year high of 5.25 percent today, surprising all of the 52 economists in a Bloomberg survey. Risks of faster inflation ``now appear more to the upside,'' the bank said in a statement. The pound rose and bonds fell.

``It's a result of the bank being very worried about the January wage round,'' Roger Bootle, an economic adviser to Deloitte & Touche LLP who formerly advised the Treasury on interest rates, said in an interview. ``Another rise is in the cards, and there may be more after that.''

In Denmark, negotiations are also currently commencing between the Unions and employer associations and given the Danish economy's rampant pace in 2006 higher wages are on the top of the wish list for employees. I will probably have more to say on the Danish economy at some later point but for now I think I have said enough.