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.
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.
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.
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.