Euro-area Q2 growth beats expectations

Today’s Q2 GDP data from the euro-area will put more pressure on the ECB to cut interest rates when it holds its next monetary policy meeting in September - while the pace of growth remained on trend and unchanged from Q1, the outlook for H2 is looking less bright.

Today’s report showed euro-area growth overall holding steady at 0.3%, narrowly beating the consensus for a lower print of 0.2%. But within that figure, the country picture is very mixed. Among the major economies, German output fell by -0.1%, a fall that was more than offset by a large 0.8% rise in Spanish output, a 0.3% increase in France and a 0.2% rise in Italy. Among the smaller economies, Latvia saw growth plummet by -1.1%, Austria showed flat growth, while Portugal and Belgium showed small increases. The better performances seen in Spain and France appear to be predicated on a pick-up in both domestic demand and trade, while in Italy a poor showing in the export sector hampered growth.

But the main concern will be Germany, where the fall in output is being pinned primarily on weak domestic demand, placing pressure on the ECB to cut interest rates further given the importance of the German economy to the euro-area as a whole. And while today’s number in itself is certainly not a disaster - indeed the reading is in line with the euro-area’s trend growth rate of about 0.3%, suggesting economic activity is neither acting as a boost nor a drag on inflationary pressures - it does potentially set some alarm bells ringing when viewed in light of recent forward-looking data, which are showing the growth story to be potentially deteriorating.

The PMI surveys for July suggest that the pace of growth over Q3 may be lower than in Q2, with activity in Germany a major source of weakness, the country battling both a depressed industrial sector and a services sector that is so far failing to respond to rising real incomes. The overall composite number for the euro-area has now fallen from 52.2 in May to just 50.1 in July, a level that shows the economy to just about still be in expansionary territory. And it is a similar picture being painted by the European Sentiment Index, with today’s report for July showing the reading for the euro-area falling from 95.9 to 95.8, a modest decline only but indicative of sentiment starting to turn more downbeat. It all suggests that the ECB’s claim at its meeting this month, that September’s meeting is “wide open,” is possibly a little fanciful, with the balance of risk appearing to be tilted to the downside. And if tomorrow’s CPI numbers show inflationary pressures continuing to ease- albeit slowly – the pressure will grow for another 25bps cut to be delivered in September.

Going forward, however, the ECB will move cautiously. In a similar story to the UK, services inflation remains high still and this will act to deter the ECB from easing policy too rapidly. Accordingly, we look for a 25bps cut in September, followed by a further cut in December.