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Germany and France economic divergence – Sober Look

The Eurozone recovery continues to be uneven, powered primarily by a pickup in export-driven manufacturing and with only some nations participating. In particular we are witnessing a significant divergence between the area’s two largest economies, Germany and France. As German manufacturing firms gain momentum (see post), the French recovery has stalled.

The Telegraph: – Figures showing private sector growth across the Eurozone have underlined the widening chasm between the bloc’s economic giants, Germany and France, with the latter increasingly looking like the “sick man of Europe”. …

… looking at the separate surveys, it is clear that Germany is pulling away from France. Germany’s manufacturing sector grew at its fastest clip in 30 months, and services are expanding too. But in France, both sectors are in a sharpening decline.

it’s the unbalanced nature of the upturn among member states that is the most worrying. France looks increasingly like the new ‘sick man of Europe’, as a second successive monthly contraction may translate into another quarterly decline in GDP, pushing the country back into a technical recession. In contrast, the December survey data round off a solid quarter of growth in Germany, in which GDP looks set to rise by 0.5pc.

The following chart of manufacturing PMI trends tells the story of divergence. Note that a reading below 50 represents a contraction in the manufacturing sector.


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OECD warns of Eurozone deflation risks; suggests ECB consider non-conventional measures – Sober Look

As a follow-up to an earlier discussion on rising deflationary risks in the Eurozone (here), it seems that the OECD is now also growing concerned about this issue. The latest economic report is openly suggesting that the ECB consider non-conventional policy measures (such as LTRO or securities purchases). Below is a good summary of OECD’s assessment of the situation in the euro area.

OECD: – In the euro area, recovery is lagging and uneven, unemployment – especially among the young – remains very high and inflationary pressures are very subdued. The ECB should consider further policy measures if deflationary risks become more serious. Current account adjustment is advancing in the periphery but price adjustment alone will not work given the impossibility of reconciling deflation, needed to regain competitiveness, and achieving nominal growth to support debt sustainability. Much less adjustment, if any, is taking place in surplus countries. More durable and symmetric adjustment is needed through reforms to labour and product markets, including liberalisation of services in Germany that would strengthen and rebalance demand.

Weakness in the banking system remains a major drag on growth in the euro area. The Asset Quality Review and stress tests in 2014 must be implemented rigorously – and followed up by bank recapitalisation where needed – to restore the transmission of monetary policy, strengthen financial-system stability and get credit moving again to enhance the effectiveness of structural reforms and support growth. Failure to use this opportunity could impair confidence in European banks and sovereigns. There is progress towards banking union but the transition promises to be complex and delicate as the criteria and responsibility for regulation, supervision, and resolution of banks have to be clarified.

OECD’s chief economist, Pier Carlo Padoan, said that the Eurozone deflationary risks “may be slowly increasing” and “the ECB must be very careful and be prepared to use even non-conventional measures to beat any risk of deflation becoming permanent.”

Some at the Bundesbank will likely oppose any such action by the ECB. But it’s becoming increasingly difficult for German central bankers to argue that deflation is not a threat to the area’s economy. Today we saw the German PPI number fall below analysts’ expectations, with the year-over-year measure moving deeper into negative territory.

Econoday: – The ongoing softness of both the headline and core PPI continues to bode well for subdued CPI inflation (1.2 percent in October) over coming months. As such, today’s report will do nothing to deter speculation in financial markets that November’s ECB ease will not be the last of the cycle.

If this continues, the ECB will be under increasing pressure to take further (and most likely unconventional) policy action.

The Independent: – The eurozone must follow the examples of the UK, US and Japan by turning to the printing presses to avoid the threat of damaging deflation, according to an assessment by a leading economic think-tank [OECD].

OECD Economic Outlook press conference

More on the OECD report here.

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In spite of currency disadvantage, Germany competes on brand – Sober Look

Germany’s trade figures continue to surprise to the upside. The latest merchandise trade number came in at €18.9bn, while according to Econoday, economists were expecting €15.5bn.

Source: Econoday

The question of course is how does Germany do this given that it is competing directly with Japan in global markets. And Japan has had one key advantage – a weakening currency, which makes its product cheaper. The chart below shows the value of the euro in terms of yen (EUR/JPY), with the euro now at recent high against the yen.


Is there a different product mix between Germany and Japan? Certainly. But according to CIBC the product overlap with Japan is the highest for Germany vs. other Eurozone nations. Machinery, electronics and cars represent a substantial component of both nations’ exports.

Source: CIBC

So how does Germany compete so successfully in spite of this currency disadvantage? The answer seems to be that Germany can compete on brand strength even at higher prices.

CIBC: – The [euro] strength against the yen will persist, a challenge largely for German exporters as they compete closely in areas such as autos and electronics. However, with many consumers prepared to pay a premium for German engineering, its exports are often less sensitive to price changes.

Indeed when compared with its Eurozone peers, German exporters boast the least price-sensitive merchandise. For example, a 10-20% higher price on a high-end German car is less likely to motivate someone to switch to a Japanese car – particularly in markets like China.

Source: CIBC

Going forward, German firms will be getting some tailwinds from Mario Draghi’s accommodative monetary policy. The ECB overnight rate is now at record low. That should limit the euro’s appreciation and provide some price stability for German exporters.

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