Euro Zone Stuck in First Gear
Pressure on ECB Will Grow and Government Bond Yields Could Fall Further
These weren't the growth numbers the euro zone was looking for. Gross domestic product in the economies that share the single currency grew just 0.2% in aggregate in the first quarter, half the pace forecast and a real disappointment that contrasts with upbeat sentiment data.
The numbers challenge the European Central Bank's belief in a gradual economic pickup and will increase fears about persistent low inflation. That will encourage markets to bet even more heavily on ECB action—even if quantitative easing remains the bank's last-resort option.
Overall, there were more negative surprises than positive in Thursday's data. Of the 13 euro-zone countries that reported quarter-on-quarter data, six contracted, one stagnated and six expanded. Germany grew 0.8%, a strong result thanks exclusively to domestic demand, and Spain showed signs of benefiting from its economic overhaul efforts, gaining 0.4%.
But disappointments were many. France managed to underperform expectations for slight growth and stagnated, while Italy's economy unexpectedly went into reverse, shrinking 0.1%. The big shock came from the Netherlands, where GDP fell 1.4% on the quarter—although a big chunk may be the result of a warm winter that led natural-gas exports to fall by more than a quarter year-on-year. Still, the decline in Dutch output was enough to knock 0.1 percentage point off euro-zone growth as a whole.
True, the headline numbers are somewhat at odds with survey and other data. Markit's purchasing managers index, the European Commission's Economic Sentiment Indicator and the Banca d'Italia's EuroCOIN index, which has historically tracked euro-zone GDP well, have all been upbeat recently. While the warm winter led to weak industrial production due to lower energy demand, euro-zone manufacturing output has been buoyant, rising at a 3.7% annualized rate in the first quarter, JP Morgan notes. Retail sales have been rising.
Nevertheless, the failure of the euro zone to accelerate will mean more calls for action from the ECB. Had growth improved in general, that would have helped the ECB's case: it could be argued that France and Italy really need domestic efforts to carry out economic reforms rather than just further loose monetary policy. But slow growth across the euro zone is a concern, as it means the output gap will close only slowly, weighing on inflation. The ECB Thursday published its latest survey of professional forecasters, which saw projections for inflation lowered across the board, with 2016 inflation seen at just 1.5%.
The figures support a number of trades that are already in train: government bond yields could yet fall further on expectation of an ECB response, and euro-denominated corporate bonds should fare well. The euro has fallen sharply in the past week, and could come under further pressure.
ECB President Mario Draghi has said that policy makers were "comfortable with acting" at the bank's June meeting. Faced with a slow-moving euro-zone recovery, the ECB may now need to shift its response up a gear.