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Forex Blog - FX Briefing - Eurozone: economy down, euro down

FX Briefing 1 August 2008

Highlights

·        In Q2 GDP in the eurozone could have fallen for the first time

·        Sentiment indicators show sustained downswing in the eurozone

·        Only a matter of time until ECB adjusts restrictive stance

Eurozone: economy down, euro down
The euro is losing steam. It did not even manage to breach 1.60 in mid-July when the credit crisis intensified in the US. Since then, the euro has been weakening. Towards the end of the week, it had fallen to a mere 1.56.

The euro’s movement is not based on the dollar strengthening: the problems in the housing market and the financial sector are still weighing on the US economy. In the second quarter, GDP growth accelerated somewhat to an annualized 1.9%, but this was due to the 100 billion dollar stimulus package, still robust foreign demand and non-residential construction, which shot up unexpectedly. All these factors are temporary. We are therefore expecting US economic growth to be sluggish at best in the forthcoming quarters.

It can be assumed that forex markets have priced in the US crisis to a large extent. The potential for disappointment and hope are more or less evenly balanced. An economic slump in Europe resulting in monetary policy loosening has not been priced in, however. But there are increasing signs that developments could be heading in that direction.

It now looks very much as though the second quarter could turn out to be the first quarter with negative growth ever since the introduction of monetary union. Admittedly, this is partly due to special factors, mainly in construction investment, but the weakness in private consumption has undoubtedly played a role too: in the second quarter, retail sales in Germany slumped by 2.4% in real terms, and in Spain by 2.3%. It looks as though they dropped in Italy too; in France, expenditure on manufactured goods stagnated. But on the production side, things do not look rosy either: Production in the eurozone (excluding construction) has been moving sideways since summer 2007. In May, it was below the previous year’s level. The slight increase in Q1 will probably have been wiped out in Q2.

The results of various national surveys and that of the EU Commission confirm that economic
activity in the eurozone is falling sharply. The EU Commission’s Economic Sentiment Indicator (ESI), which reflects both business and consumer economic sentiment, declined in July from 94.8 to 89.5. This is over 10% below the long-term average (=100) and corresponds roughly with the record lows reached during the recession of 2001 and 2002.

The chart shows that there is a strong correlation between the ESI and GDP growth in real terms in the eurozone. According to the current level of the ESI, real GDP growth in the third quarter could fall to less than 1% year-on-year. This would be in line with our growth forecast, in which we predict that Q3 will be another negative quarter. This picture is confirmed by “hard data” such as most production and consumer indicators (particularly retail sales). The sustained decline in industrial new orders is also pointing in that direction.

With the prospect of a significant growth slowdown in the eurozone, the ECB will see inflation risks diminishing. Moreover, the central bank will have been relieved at the recent fall in oil prices to below $125 per barrel. However, for the time being, the ECB is not likely to be in any hurry to alter its restrictive policy stance: firstly, interest rates were raised only a month ago; secondly, oil prices have just dropped back to their mid-May level, on which the last projections had been based. And finally, the growth slowdown must, up to a point, be regarded as welcome from a monetary policy point of view.

Against this backdrop, we are expecting the ECB Council to note the increasing growth risks at next Thursday’s meeting, but to basically confirm its monetary policy stance (no interest rate bias, inflation risks prevail). It is, however, only a matter of time until this changes: inflation rates will begin to fall in the next few months, and there will be increasing signs of a downswing. We expect the forex market to price in this development and EUR-USD to fall significantly below 1.55..
Stephan Rieke +49 69 718-4114

Economics Department
+49 69 718-3642
volkswirtschaft@bhf-bank.com
Foreign Exchange Trading
devisenhandel@bhf-bank.com
Jörg Isselmann
+49 69 718-2695
Matthias Grabbe / Klaus Näfken
+49 69 718-2688

This report has been prepared by BHF-BANK Aktiengesellschaft on behalf of itself and its affiliated companies (together "BHF-BANK Group") solely for the information of its clients. The information and opinions in this document are based on sources believed to be reliable and acting in good faith, but no representation or warranty, express or implied, is made by any member of the BHF-BANK Group as to their accuracy, completeness or correctness. Opinions and recommendations are given in good faith but without legal responsibility and are subject to change without notice. The information does not constitute advice or personal recommendation, for which the duty of suitability would be owed, but may facilitate your own investment decision. Moreover, you should seek your own advice as to the suitability of an investment matter mentioned herein. Investors are reminded that the price of securities and the income from them can go down as well as up and that the past performance of an investment or a market is not necessarily indicative for future results. This document is for information purposes only. Descriptions of any company or companies or their securities mentioned herein are not intended to be complete, and this document is not, and should not be construed as, an offer to sell or solicitation of any offer to buy the securities mentioned in it. BHF-BANK Group and its officers and employees may have a long or short position or engage in transactions in any of the securities mentioned in this document, or in any related securities. This publication must not be distributed in the United States.

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All rights reserved. Please mention source when quoting from it.

 

 

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