Friday, August 21, 2009

Germany and France moving higher?

Following positive growth in Q2 in Germany and France, today's manufacturing and services PMI contained another positive surprise for both with the French manufacturing moving to 50.2 and the German services PMI surging to 54.1, i.e. above the 50-level. Both countries exhibit only limited internal imbalances (no overvalued housing markets, no over-indebted consumer and a relatively moderate level of consumption relative to GDP in the mid-50% area). In Germany, the problem is more its huge export-dependency as well as the significant losses in the banking sector (which I think stems largely from the fragmented domestic banking market where banks instead of merging to increase market share and profitability bought significantly into securitized assets to generate income). The French dependency on exports is significantly less but exports still account for roughly a quarter of GDP. However, the corporate sector is showing a significant financial deficit. Therefore, for these two countries (together with some others such as for example China or Switzerland) the role for fiscal policy has been more promising in stimulating internal demand to cushion the downturn and help the economy to recover amid increasing domestic consumption. While several measures are likely to just have brought future consumption forward (such as cash-for-clunkers), in general, it seems that these measures have proved rather successful.
Furthermore, given that the rise in unemployment has been relatively moderate in both countries so far, the risk of wage-deflation spiral is also not pronounced and the easing inflation rates will rather help to improve purchasing power. This seems to be confirmed by this article stating the purchasing power of French families is maintained despite the crisis (it is in French).
On the other side, in countries where a debt-fuelled housing and consumption boom has left the consumer overindebted and undersaving and the economy overly dependent on consumption (such as the US, the UK but also Ireland and Spain), the longer-term outlook for internal demand remains much more subdued and the ability of governments to stimulate consumption more limited.
Finally, Germany has - amongst other things - been burdoned earlier this decade by too high real interest rates within the Eurozone (weaker economy than the rest of the Eurozone--> lower inflation -->higher real interest rates). This was also a reason why no housing boom materialised and why households rather saved than spent. However, with growth seemingly recovering whereas other Eurozone countries remain mired in recession, it could well be that instead of too high real interest rates as over the past decade, they could become too low for the German economy. This would be an additional factor in helping the economy to shift its focus more towards domestic consumption and investment and away from exports.

Overall, the outlook for Germany and France remains relatively favorable and the impact from easy macro-economic policy promises to be more effective than elsewhere.

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