The manufacturing sector in particular is the one that has turned into a drag on overall growth as it has felt the fallout from geopolitical trade tensions and is likely to come under further pressures for the rest of the year. Germany will increasingly be in the firing line especially if growth doesn’t improve soon.
Another painful call for caution was given today with the manufacturing PMIs for the Eurozone highlighting the sector’s contraction in Germany, the UK, and Italy as well. The German outcome was revised lower at 43.5, while the UK’s August Manufacturing PMI was seen at the lowest level of the past 7 years. Remarkably, the releases show that countries like France, who focused on domestic demand rather than foreign, have been less affected in a period of a high downside growth risk globally.
Meanwhile, German car producers are still suffering from the fallout from the diesel scandal but will also be in the firing line for another round of US tariffs on imports from the EU, which seem increasingly likely considering that there is little to no progress in trade talks.
The sector is also feeling the pressure from a no-deal Brexit scenario. Indeed, given the fact that Boris Johnson has been given moral backing by US President Trump, he could well back this up with tariff threats in September, which would strengthen the UK’s hand in the last weeks for possible talks ahead of the October 31 Brexit date. In that scenario and with signs that Germany’s weakness is spilling over to the rest of the Eurozone, pressure on Berlin to ditch the focus on budget consolidation is rising.
But let’s see what technical recession actually means and why it is important.
Recession, simply put, is the decline in economic activity, usually visible by a significant drop in five of the most important economic indicators, i.e. real gross domestic product (GDP), income, employment, manufacturing, and retail sales. Technical recession though refers to the sequential decline in GDP for the past two quarters. This presents economic contraction since the GDP measures the value of all goods and services produced in a country during a specific period of time, in other words, the total expenditure in the economy.
The potential of a technical recession is visible in the Eurozone and Asia:
PMI manufacturing data out of both Europe and Asia have painted a worrisome picture, overall, today, showing the direct and indirect impact of the Trumpian era of trade warring. This comes with additional US tariffs being implemented on Chinese goods, as well as retaliatory levies from China. China’s official August manufacturing index dipped to 49.5 below the 50 expansion/contraction line, despite the improved CAIXIN PMI to 50.4 from 49.9.
In the rest of Asia, export-oriented South Korea, Japan, and Taiwan also showed their respective manufacturing sectors to be in contraction, shining a light on the indirect effect of geopolitical tensions.
Meanwhile, in the Eurozone, German GDP contracted -0.1%, which added to expectations for ECB stimulus. Overall, it was largely as expected number for Q2 GDP, with the main weakness in exports and an unexpected contraction in investments. The scaling back of investment and the weaker than expected consumption profile tie in with the ongoing deterioration in business confidence and signal a more lasting slowdown, with the risk of a technical recession. The composite PMI fell back to 50.9 in the final July reading, the lowest since 2013 and effectively signaling stagnation in overall economic output. ZEW and Ifo surveys also continue to decline.
Moreover, the drop in German Q2 GDP was a reminder that the fallout from geopolitical trade tensions and Brexit uncertainty is threatening to derail the global economy.
What could happen this week?
Another confirmation of downside risk to the growth outlook could be seen this week, as Eurozone Q2 GDP growth will be announced on Friday. It is anticipated that the report will emphasize the two most export-oriented economies, i.e. Germany and Italy.
Looking ahead, the weakness is likely to persist in the third quarter, as confidence data remains depressed, and the weakness in manufacturing is starting to impact the labor market. Meanwhile, a potential announcement of additional tariffs on imports from the EU by the US will increase the pressure on the European economy, as the US remains the largest destination of EU exports. In 2018 EU exports to the US reached EUR 407 bln, with imports from the US coming to just EUR 268 bln.
Theoretically, however, if the economy shows positive growth for the remaining two quarters of this year, Germany will avert a recession for the calendar year 2019.
How could a recession affect us?
In general a recession, technical or not, has an immediate impact on the labor market, consumer behavior and the interest rates of a country as well.
- In the labor market, unemployment rates run extremely high due to the decline in investment into the country. As the unemployment rate rises, consumer purchases fall off even more.
- As the recession affects interest rates, spiking good and services prices, consumers often cut spending on non-essential items and prefer to spend money on necessities only, due to their insufficient income.
- Production slows down, thus giving rise to prices.
- Businesses start consolidating their expenses, and that suggests job cuts.
- Manufacturing, construction, wholesale and retail trade, as well as accommodation are at a higher risk of being affected.
Hence as we have stated the direct and indirect impacts of the recession, the question is how long it will take until the weakness in German manufacturing spreads, especially as the improvement in the labor market is already starting to wane. The same question stands for the Asia region as well.
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For now, optimism that the situation will change is based on Central banks. In China, the State Council’s financial stability and development committee announced that it will keep a prudent monetary policy, with “reasonably ample” liquidity and “reasonable growth” in aggregate financing. In Europe, the ECB is holding on track with another comprehensive easing package and a further cut in rates.
Andria Pichidi, Market Analyst at HotForex
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