Eurozone recession continues
 
Azad Zangana, Schroders’ European economist, comments on the eurozone GDP data announced on 15 May and its implications for the outlooks of individual member states

According to Eurostat, the initial estimate of eurozone first-quarter GDP is -0.2%, meaning the monetary union in aggregate recorded its sixth consecutive quarter of recession, dating back to the third quarter of 2011. A combination of aggressive fiscal tightening, a crisis in peripheral sovereign bond markets and a credit squeeze have all contributed to the ongoing decline. Although the fall in GDP was slightly worse than consensus estimates of -0.1% (Schroders forecast -0.2%), the pace of contraction has reduced from -0.6% at the end of 2012.

Of the major countries that have reported their GDP, only Germany managed to eke out some positive growth – albeit just 0.1%. There are no detailed figures of the breakdown of GDP components yet for Germany, but its national statistics office reports poor weather in the first quarter had an unusual impact on activity. The household sector is reported to have improved while net trade did not make a negative contribution to growth as was the case at the end of 2012.

"Of the major countries that have reported, only Germany managed to eke out some positive growth."

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France on the other hand does publish more detailed statistics with its initial estimate. French GDP contracted by 0.2%, repeating the performance from the end of 2012, and slipping into a double-dip recession. There was initially some confusion as to whether France had actually ‘triple-dipped’. Past data had shown France had double-dipped at the start of 2012, but the new figures show the previous recession has been revised away, making the current recession the double-dip. Within the details, household and government expenditure were flat on the quarter, while investment and net trade both made negative contributions. 

Meanwhile, the third and fourth largest member states, Italy and Spain, both contracted by 0.5% in the first quarter, although both have been in recession far longer than Germany and France. Italy has been in recession for seven quarters, with its GDP falling 4.1% since its previous peak. Spain has been in recession for six quarters, with a 2.9% fall in GDP since its previous peak. 

Looking ahead, we expect activity to continue to gradually improve through this year, although member states that are forced to carry out tough fiscal consolidation will lag behind those that do not. Specifically, we forecast Germany, Finland and Austria to outperform the rest, aided by the recent weakness in the euro, the improvement in external demand and even lower interest rates thank to the European Central Bank. Meanwhile, we expect France to exit its recession later this year, while Spain, Italy and Portugal are all unlikely to return to sustainable growth before 2015.

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ECB hints at negative rates for banks
 
Azad Zangana, Schroders’ European economist, believes the 25 basis point cut in headline interest rates announced by the ECB on 2 May is marginally helpful but unlikely to solve any of Europe’s fundamental problems

After 10 months on hold, the European Central Bank (ECB) cut its main policy interest (refinancing) rate from 0.75% to 0.50% as macroeconomic data continued to worsen in the eurozone. Leading indicators of economic activity over the past two months have suggested the recession in the eurozone could deepen over the second and third quarters of this year.

While the recovery is being called into question, underlying inflation is falling across the eurozone. The annual headline inflation rate has fallen from 2.2% at the end of 2012 to 1.2% in March – meeting the ECB’s target of below, but close to, 2% annual inflation, but also becoming a little too low for comfort.

"The most significant comment was the hint the main policy rate could yet be reduced further - but also the deposit rate could be cut from zero into negative territory."

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The falls have been largely as a result of lower inflation from energy and transportation costs. However, with the economy in recession and unemployment rising sharply in a number of states, rising spare capacity – especially in the labour market – is causing a build-up of deflationary pressure.

In our view, the cut in the main policy interest rate will not have a significant impact on the economy. Those banks that are able to access funding from financing markets (and therefore able to lend) were already enjoying much lower interest rates thanks to the huge amount of liquidity the ECB has pumped into the system. The banks that are reliant on the ECB for funding will benefit from the reduction in their funding cost, but are unlikely to be in a position to increase lending, and so will not pass on the rate cut to households and businesses. 

In addition to the cut in the main policy rate, the ECB also reduced the marginal lending rate, which is paid by banks that borrow more than the prescribed usual amounts, from 1.50% to 1%. The ECB also extended the generous ‘full allotment’ mode of banks financing until at least July 2014.

ECB president Mario Draghi stated the bank was exploring options of using the central bank’s balance sheet to support additional lending for small and medium-sized enterprises. This would be done through the restarting of the asset-backed securities market in Europe, which would allow the ECB to buy and hold securitised debt and hopefully lower the cost of funding for corporates.

In addition to the interest rate cut, the most significant comment made was the hint the main policy rate could yet be reduced further, but also the deposit rate could be cut from zero into negative territory. This would follow the actions of the Swiss and Danish central banks, which essentially charge banks to hold deposits, therefore encouraging them to use their deposits in a more productive way for the economy. 

Overall, the cut in ECB interest rates is marginally helpful but unlikely to solve any of Europe’s fundamental problems, which are bearing down on the economy. The hint the ECB would consider a negative deposit rate is useful in prompting banks to reallocate their capital to more productive areas of the economy – however, there is a risk the move could encourage banks to charge depositors, and for those depositors to withdraw their cash, and opt for hiding their savings under their figurative mattresses.

Finally, the potential purchases of loan backed securities would be positive for stimulating lending to the real economy. However, we are unlikely to see purchases begin before the autumn as the need for the ECB to coordinate with the European Commission will take time.