Ignacio de la Torre. Porfessor. IE Business School
15 May 2015
For the first time in seven years, Europe is starting to show signs of solid growth, bringing an improvement in the economy that will be surprisingly bullish, and which is set to gather pace over the next few years.
On October 1, 2014, I expressed the view that in 2015 the European economy would do what the Spanish Economy had done in 2014. Debates at the time were centered around the double dip recession that was believed to be on its way due to the weakness of the German, French and Italian economies. For a long time now, my stance has been that Europe’s performance will bring the big positive surprise of 2015.
Figures published over the course of the last few weeks would appear to indicate that the surprise is starting to take shape.
Germany is showing clear signs that an economic upturn is gathering pace. Its GDP grew in the last quarter by 0.7, which led to the consensus that annual economic growth could reach up to 2%. This growing strength comes from two main sources: first, the surprising acceleration of consumer activity with major increases during the months of December and January, increases which will continue to grow in lockstep with continued rises in consumer confidence (GsK index). Second, German exports are reacting extremely well to the weakness of the euro, as evidenced by figures issued in December - a major factor considering that almost half of Germany’s GDP is driven by exports. Moreover, the incipient recovery of consumer levels in other countries is also fuelling German exports. The Spanish economy, meanwhile, continues to accelerate for reasons covered in detail in earlier articles. The third quarter may bring a quarterly growth rate of 0.8%, which would translate into an annual growth rate of 3.2%, which means that Spain would be spearheading growth among the big Western economies, as stated in another recent article of mine.
Italy is also sending out signals of recovery, with marked improvements in consumer confidence (at its highest level since 2002), in business confidence (ISAE), and in the purchasing manager index (mPMI). These trends could signal that the Italian economy is beginning to grow (its growth rate stood at 0% in the fourth quarter). France, meanwhile, also has a positive outlook, with the approval of specific structural reforms, excellent consumption figures and rising consumer and business confidence. France is probably set to speed up its quarterly growth rate, which currently stands at 0.1%. These four economies make up the most relevant part, economically speaking, of the eurozone. Outside the eurozone, both the UK and Switzerland continue to emit good growth figures.
What are the underlying reasons for these positive signs?
First, credit is starting to flow again in the eurozone. Spain’s economy is very dependent on bank credit, and when faced with an unprecedented banking crisis, its GDP suffered more than other economies with bigger diversification and sources of funding. Basically, the majority of Europe’s banking system has been overhauled and now has sufficient liquidity, these being the key factors that underlie the amount of credit on offer. Given that the demand for credit stopped falling toward the summer and has been rising since autumn, it follows that a higher level of credit on offer has coincided with a greater level of demand, and that we are gradually starting to observe larger increases in the new flows of credit, which in turn impact GDP. These signals also explain why the growth of monetary mass has continued to accelerate toward the current rate of 4%.
Second, the deflation caused by the drop in oil prices is harmless, because it leaves greater power in consumers’ hands, who reacts by buying more. This factor explains the surprising consumption figures for German, France, and Italy.
Third: when there is strong growth of levels of consumption, companies increase their levels of production, especially if they have access to credit. This explains why there is so much investment going on, which, generally speaking, is also strongly linked to job creation. This is why unemployment levels are falling in the Eurozone (by up to 11.2%), a trend that is led by Spain.
Fourth: the weakness of the euro is relevant in an economy that depends to a great extent on exports, as is the case of the eurozone. Hence, exports are gradually picking up pace, which further adds to the level of GDP.
As always, there is always some kind of risk. The Greek situation could derail things, as could a rise in interest before time, or faster than expected, by the FED and the ECB, or worsening geopolitical tensions in Eastern Europe. Overall, these risks apart, GDP growth should continue to accelerate (the eurozone could already be growing at a rate of 1.5%, which would increase consensus estimates, and would therefore grow in 2015 at a level very similar level to Spain’s rate of growth in 2014, namely 1.4%).
Hence, despite the large number of negative surprises coming out of so many emerging economies, starting with China, for the first time in seven years Europe is sending out some very solid signals that it is about to rise again like the phoenix. It is already surprising with its bullish performance and it is a trend that will gather speed in the coming years.