* Business Confidence Surveys Suggest The Economic Trough Is Still Some Months Away
From economic research by David Mackie, Morgan Guaranty Trust Co.
BridgeNews LONDON--Euro-area data released over the past couple of weeks have prompted some forecast revisions, to both growth and inflation. Growth looks set to be weaker than expected, while inflation looks set to be higher. Although this less attractive outlook might be thought to create a dilemma for the European Central Bank, the forecast still expects 50 basis points of easing between now and year's end. Much of the deterioration in inflation is of a temporary nature, driven by food and energy prices, and weaker growth will put downward pressure on core inflation.
The next move in policy rates is likely to take place in early August, just ahead of the summer recess, but only after more signs of growth weakness and clear indications that headline inflation has peaked. Growth now expected to be significantly below potential For some time now, it has looked highly likely that Euro area growth would slip to a below-potential pace during the course of this year.
It now appears probable that this patch of weakness will be both deeper and more prolonged than previously expected.
Three developments have prompted these forecast revisions: Growth in the first quarter was weaker than expected. With a greater loss of momentum than anticipated, the risk of weaker growth in the subsequent couple of quarters increases.
The monthly real economic data suggest that the second quarter started on a weak note. In the absence of large monthly gains during the course of the quarter, which seem unlikely, GDP growth in the second quarter is almost certain to be significantly below the first quarter pace.
Surveys of business confidence suggest that the trough is still some months away. Normally, the pace of deterioration in business surveys starts to moderate as the trough approaches.
This has not happened yet. For example, since the peak at the end of 1999, general output expectations in the INSEE survey have fallen at an average monthly pace of 3 percentage points. But, in the past three months, the average monthly decline has been 11 percentage points. Similarly, the average monthly decline since the peak in the area-wide PMI in April last year has been 0.9 points. But in the past three months, the average monthly decline has been 1.3 points.
Among demand components, the main forecast change has been to consumption. Although tax cuts have boosted household disposable incomes, higher food and energy prices have depressed spending power. Higher-than-expected inflation has meant that the boost from the fiscal easing is coming through more slowly than originally thought. In addition, the pace of job creation has slowed dramatically, influencing household confidence.
This has been evident in the German labor market data for some months. Last week, it became clear that the French labor market has also cooled. After falling at an average monthly pace of 35,000 last year, unemployment was down only 22,000 per month in the first four months of this year; in the past two months, the average decline has been only 9,000. ? French household fears about unemployment have leapt up by 47 points in the past two months, after having held within a 10- point range in the prior six months. The jump in inflation in May likely means that areawide headline inflation will stay above the ECB's zero to 2 percent tar-get range until early next year.
After a peak of 3.2 percent in May, headline inflation is expected gradually to decline. However, as far as food and energy prices are concerned, the fall in inflation rates is entirely due to base effects. The forecast assumes that food and energy prices will hold at recent levels. Only with core inflation is a genuine improvement assumed in the underlying inflationary dynamic.
Slower growth is pushing capacity utilization rates down to such an extent that firms will have little pricing power. This is already evident from a sharp decline in survey measures of pricing intentions.
This week brings even more survey data for May, including the PMI survey for services and the EU survey. There is a raft of German data for April, ranging from manufacturing orders, industrial output and unemployment.
All of these indicators are expected to be weak. Eurostat also publishes its estimated first-quarter GDP. Judging by the national releases, the quarterly gain will be about 2 percent at an annual rate.