Euro-Area Slowdown Puts Onus on Germany as Brexit Risks Gather

What European Earnings Season Signals for Investors
  • Eurostat confirms second-quarter economic expansion of 0.3%
  • Greece unexpectedly avoids falling into another recession

Germany kept its place as the pillar of the euro-area economy in the second quarter, offsetting stagnation in Italy and supporting momentum before Britain’s vote to leave the European Union.

While expansion in the region cooled to 0.3 percent in the three months through June, that was in line with economists’ expectations. It was also the 13th straight quarter of growth. The German economy expanded 0.4 percent, twice as fast as predicted, while Italy’s unexpectedly stagnated.

That highlights diverging fortunes of the euro area’s 19 members at a time when the recovery as a whole is facing risks from weaker world growth to terrorism threats and political uncertainty. European Central Bank President Mario Draghi has held out the prospect of more stimulus if a slowdown weighs on inflation. The International Monetary Fund already scrapped its forecast for a pickup in global momentum this year following the U.K. referendum.

The slowdown “seems in line with the growth trend of the euro-zone economy,” said Bert Colijn, senior euro-area economist at ING Bank NV in Amsterdam. “The question remains if even this lower growth rate can be sustained in the third quarter. With Brexit uncertainty weighing on exports and industrial weakness, it seems that the consumer has to carry a lot of the weight.”

Private consumption has been the driver of economic growth recently, while net trade damped output in the past three quarters for which a breakdown is available. Eurostat will publish second-quarter details on Sept. 6.

Growth in the April-June period was also stronger than anticipated in the Netherlands, where GDP increased 0.6 percent. Greece’s economy unexpectedly grew 0.3 percent, following a 0.1 percent contraction at the start of the year. Portugal’s 0.2 percent expansion was weaker than economists forecast.

In addition to terrorism fears in countries like France, whose economy stagnated in the second quarter, bad loans are weighing on Italian banks, damping credit supply, and political gridlock in Spain is fueling uncertainty among consumers and companies. With those being just some of the challenges euro-area countries are facing aside from Brexit risks, Germany may have to play an even bigger role in ensuring the region’s recovery remains on track.

Drawing Strength

Europe’s largest economy is drawing its strength from domestic demand, with record-low unemployment and rising wages bolstering growth, even as the main driver of the last period’s results was trade.

“The figures for the second quarter are somewhat above expectations and underline the relatively robust economic trend in Germany,” Bundesbank Deputy Chief Economist Stephan Kohns said in an e-mailed statement.

Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt, says that monetary policy is already “far too expansionary for Germany” and more ECB stimulus will give the economy another boost. He lifted his 2017 German GDP forecast to 1.8 percent from 1.5 percent after Friday’s report.

The Frankfurt-based ECB is scheduled to set policy on Sept. 8. The Bank of England has already cut rates to a record low in a package of stimulus measures.

So far, there’s little evidence of any impact of Brexit on sentiment and production at the euro-area level. Purchasing managers surveyed in July reported accelerating output, and a European Commission survey showed economic confidence unexpectedly increased. One reason for optimism may be full order books, which are set to shield manufacturers from potentially dwindling demand for another four months.

“My sense is that the ECB probably has some more work to do,” said Jonathan Loynes, chief European economist at Capital Economics in London. “There is a big divergence between different countries and the outlook is still the one of pretty sluggish economic growth in the next quarter or two.”

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