Don’t rely on German fiscal medicine to fix economy’s ailments (Bloomberg)

Germany, the great manufacturing powerhouse and the largest economy in Europe, is stuck in an industrial slump as it becomes a victim of the US-China trade standoff. Stuck as a sick patient, in need of some fiscal medicine, with Angela Merkel and her colleagues unlikely to administer the required remedy.

As industry plays such a significant role in German growth, the trans-pacific spat has left the nation in a difficult situation, with many firms projecting a muted outlook. In fact, figures for June’s Industrial Production registered their biggest annual decline in almost a decade. Also, the nation’s Manufacturing Purchasing Managers’ Index (PMI) suffered the steepest fall in overall conditions since mid-2012, amid falling sales to China and an automotive slump. As such, a Bloomberg survey of economists predicts that the German economy probably contracted 0.1% in Q2 2019.

It’s almost certain that a slowdown in the extended Eurozone area will cause the European Central Bank to ease monetary policy when policymakers next meet in September, and this could help weaken the Euro, making Germany’s exports more competitive. However, the institution would much prefer not to go it alone, especially at a time when investors pay the German state a premium for lending it money—the entire German yield curve is in negative territory. But in Germany, there are constitutionally enshrined barriers to ramping up spending. In periods of growth, new federal debt must not exceed 0.35% of nominal economic output.

Meanwhile, the debate in Berlin has begun on whether some fiscal stimulus is necessary. Merkel’s Social Democrat coalition partners are the main proponents, as they seek to support efforts to combat climate change. With a debt/GDP ratio hovering just above 50%, Germany is arguably in the best position to deliver increased public spending. It could even help develop new areas of the economy, diversifying them from over-reliance on manufacturing. Just don’t expect it to be popular enough to actually happen.

Bottom line: The suggestion of Germany taking on new debt has historically been a taboo topic, but there are signs of that abating. Last week’s reports that the government may consider running a small deficit to finance a costly climate protection programme has opened the door to so-called ‘Green Bonds’. This would be a positive step in supporting an economy that’s been collateral damage in global trade disputes. Still, with global sentiment continuing to decline, there may not be much that Germany can do to avoid recession.

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The week ahead

GBP

Unlike last week, there’s a slew of UK data releases to look forward to as the week progresses. Markets will be looking for early signals that Friday’s terrible Gross Domestic Product (GDP) data was only a temporary blip. Major political developments on the Brexit-front are unlikely as MP’s are now firmly in the middle of their summer recess.

  • Tuesday holds UK labour data—markets expect a promising bump to average earnings from 3.4% to 3.7%. Britain’s unemployment level should stay at record lows of 3.8%.
  • Inflation data will be released on Wednesday. The UK’s Consumer Price Index (CPI) has been at, or above the Bank of England’s 2.0% target in each of the previous three months; however, data for July is expected to indicate that price increases fell to 1.9%.
  • Finally, on Thursday the UK releases Retail Sales data for the month of July. The measure is the primary gauge of consumer spending, which accounts for most of the overall economic activity. It’s forecasted to fall by -0.3%, which indicates an unexpectedly quiet summer month for retailers.

USD

Interestingly, price action in the Dollar last week wasn’t really a result of any US data releases, more a by-product of heightened trade tensions and speculation that the People’s Bank of China might heavily devalue the Yuan. With a couple of important releases this week, we’ll be keen to see whether data remains ineffectual in shifting the Greenback.

  • US inflation data will be out on Tuesday with month-on-month CPI and core CPI expected to come in at 0.3% and 0.2% respectively. Muted inflation was one of the key reasons for July’s interest rate cut so this data point will be significant in anchoring expectations of future monetary policy in the US.
  • Thursday’s Advance Retail Sales release is expected to remain positive following last month’s stronger-than-expected reading. The US consumer has been key in supporting the US economy amid escalating trade tensions affecting global supply chains. This month’s reading is expected to show an expansion of 0.3% for retail sales and 0.4% for core retail sales.

EUR

Last week’s panic over the devaluation of the Yuan caused the Euro to rally back towards 1.12 against the Dollar after the pair hit two-year lows in the week prior. Once the panic died out, the common currency traded relatively flat. We will be keeping an eye on how the Euro trades during short-term shifts in risk sentiment given last week’s rally. Italian and French bank holidays on Thursday may make for reduced Euro volumes being traded this week.

  • Germany will be the focus on Tuesday for the latest release of the ZEW Economic Sentiment survey. The deterioration since April this year is set to continue with a decline to -27.8 following last month’s dismal -24.5 reading.
  • Germany’s latest GDP figure will be released on Wednesday and is expected to contract by -0.1%. With fears of recession mounting, this will be a key release this week and may trigger Euro weakness for the remainder of the week.
  • Also on Wednesday is the Eurozone’s quarterly GDP figure, which is expected to equal the Q1 reading of 0.2%. An outcome below this would be the weakest Eurozone growth since June 2013.

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