The divergence between improving confidence surveys and disappointing hard data, in the industrial sector in particular, is turning into a real conundrum. Our assumption is that the recovery in GDP growth is simply being…
Intesa Sanpaolo – Research Department
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postponed to the second half of the year, although stagnation in the first half will make 2014 a close-to-zero-growth year. For what concerns 2015, the impact of the new measures announced by the ECB does not seem decisive, also considering that it may be balanced by downside risks tied to a potential need for fiscal consolidation.
In the past month, confidence surveys confirmed indications of an economic recovery (confidence levels among both businesses and households are at their highest in at least three years); however, hard data, and in particular the trend of industrial output, keep disappointing.
Indeed, following the April rebound, industrial output plunged surprisingly in May, by -1.2% m/m. The reading was worse than even the most pessimistic forecasts. Also, the April rise was revised downwards by two tenths (from 0.7% a 0.5% m/m). May marked the sharpest month-on-month decline since November 2012. In year-on-year terms, output resumed declining in both unadjusted terms (from zero to -4.9%) and adjusted by calendar effects (from +1.4% to -1.8%, a low since September), diverging compared to the trend of surveys. Output (seasonally-adjusted) dropped below the recent low hit last August, closing back in on March-April 2009 long-term lows.
Data broken down by the main business sectors was also negative across the board, with the sole exception of the energy item (+0.8% from a previous rate of +3%), which has often moved against the overall index in recent months; all the other macro-sectors suffered declines of at 1.5% month-on-month. The same is also true for economic activity broken down by line of business: all sectors incurred a contraction in monthly terms, with the exception, outside the manufacturing sector, of extraction activities (+3.8%) and energy distribution (+0.3%); among manufacturing activities, only the production of coke and oil products (a sector which accounts for only 1.9% of the total) posted a positive change (+4%). In year-on-year terms (adjusted by calendar effects), the only sectors which retained a plus sign are, in addition to extraction activity (+3,7%), the production of articles in rubber and plastic materials (+2.9%), and the food industry (+0.2%). A standout negative performance of -6.5% was posted by the manufacture of electric equipment.
In essence, considering both the synthetic index and broken down data, the reading is markedly negative. Admittedly, it is true that the May decline was widespread across all the main European countries (Germany -1.4%, France -1.3%, Spain -0.9%), this signals that an important factor may have been the long weekend in the first week of May: the number of long weekends is a significant variable in explaining both the month-on-month and year-on-year trends of industrial output (in a model with confidence indices and self-regressive components). The significance seems to increase in phases of weak productive activity, and when the long weekend falls at the beginning of the month.
In general, hard data on output remain very volatile, and in contrast with the indications provided by manufacturing company surveys (the Istat index of business confidence in the industrial sector hit a three-year high in June; the manufacturing PMI, while down slightly in the past two months, had also risen in April to its highest level in almost three years).
The “divergence” may be due to distortions of the samples used in the surveys, caused by a loss of productive capacity (bankrupt companies) or by very negative distribution tails, given the presence of particularly negative outliers in some sectors, or even individual companies. Also, the economic difficulties faced in the past few years may have induced many companies to permanently adjust downwards their expectations, to the point that every rebound, no matter how small, triggers a surge (in surveys but not in hard data) compared to the previous situation.
In any case, industrial sector output is on course for a -0.7% q/q decline in the spring quarter, after staying stable over the previous three months: this would mark a low since the end of 2012. In other words, even assuming a rebound almost on a par with June (due to the waning of the “long-weekend effect”), in all likeliness industry will contribute negatively to value added, by around one tenth, which raises doubts over the forecasts of a return to quarterly GDP growth in 2Q 2014 (as the construction sector still seems to be experiencing a recession, and services seem stagnant).
Compared to our previous forecast of 0.3% q/q (in line with consensus), the industrial output reading alone lowers the estimate by two tenths. In our view, the second quarter should fall in the -0.1/+0.1% q/q range. As mentioned above, industry should contribute negatively to valued added by at last one tenth; consumption could accelerate moderately, from +0.1% q/q at the beginning of the year (hitting a high in over three years); a significant contribution from net exports is unlikely. While inventories are not likely to contribute as negatively as they did at the beginning of the year, they cannot be expected to visibly support the economic cycle.
The point is that the forecast for the year as a whole is strongly dependent on the second quarter: if 2Q growth falls in the indicated range, the year would close at 0.1% (assuming 0.3% q/q growth, in line with consensus, in the other two quarters). In other words, 2014 is confirming its nature as a «transition» year, in waiting for a «true» recovery in 2015 (with GDP growth of just over 1%). In fact, some confidence indices are signalling a potential new slowdown in the cycle after an expansionary phase which lasted only a few months, although we continue to believe that the risks of a fall back into recession are modest, and that the overall trend of the economy will continue to improve, albeit very gradual and modest. The economy is experiencing a stagnation phase, a sort of “limbo” between recession and recovery, that has been going on for a year, i.e. more than expected.
The other development in the past month was the disclosure of the operational details of the new accommodative measures announced in June by the ECB. Funds potentially available for Italian banks through the new TLTROs may be in excess of 200 billion euros along the entire duration of the programme (from September 2014 to mid-2016), of which around 75 billion at the first auction in September; higher collateral by around 120 billion is also a possibility, deriving from the fact that the Bank of Italy is about to widen the range of loans that qualify as security in accessing refinancing from the Eurosystem, with operational details designed to encourage lending to small and medium enterprises.
As regards the effects on the economic cycle, the Bank of Italy estimates the impact on GDP at half a percentage point (and on CPI as well), if the changes undergone on the announcement of the new measures by interest rates and the exchange rate stay in place; another half of a GDP percentage point would derive form the impact on credit, if intermediaries entirely transfer to clients the lower cost of funding, and entirely remove residual constraints on the supply of credit. In total, the effect should amount to one per cent over two and a half years (around 0.4% a year).
We are not equally optimistic on the fallout from the operation, as: 1) the changes in interest rates will not be maintained throughout the forecasting horizon (long-term rates are expected to increase in the next few years), and the scenario already prices in a depreciation of the euro; 2) the new TLTROs in themselves do not imply increased liquidity for banks (as liquidity was already unlimited), nor do they shift the balance of counterpart risks: therefore, they will not impact potential rationing, but solely translate into lower cost of funding, with positive but not decisive effects on the credit circuit, and therefore on the economic cycle. The package of measures is not enough by itself to change the expectations, and may paradoxically have more markedly positive effects in an already consolidated recovery scenario, with an optimistic outlook.
In a nutshell, we believe the positive impact of the package of measures announced by the ECB will not be decisive, also considering that it will be offset by the negative effects of likely fiscal consolidation.
Source: BONDWorld.ch
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