MacroScope

What is France to do?

It’s euro zone third quarter GDP day and Germany and France are already out of the traps with the latter’s economy contracting by 0.1 percent, snuffing out a 0.5 percent rebound in the second quarter. Growth of 0.1 percent was forecast, not just by bank economists but by the Bank of France too.

Germany failed to match its strong 0.7 percent growth in the second quarter, but expanding by 0.3 percent – in line with forecasts – it is clearly in much better shape.

The Bank of France has estimated stronger growth of 0.4 percent in the final three months of the year but the euro zone’s second largest economy is a growing cause for concern. An OECD report on French competitiveness, released overnight, said it is falling behind southern European countries that have bitten the reform bullet.

The OECD warned that markets can turn quickly on vulnerable countries although with its deep and liquid bond market, France is somewhat protected in that respect. France’s labour and pension reforms are widely viewed as being timid and with Hollande’s poll ratings at record lows there is not much chance of a great leap forward.

Spain has been much more aggressive and is seeing the benefits in terms of rising exports (and, admittedly, sky-high unemployment). So too has Portugal.

Brussels looks warily at German surplus

Barring a last minute change of heart, the European Commission will launch an investigation into whether Germany’s giant trade surplus is fuelling economic imbalances, a charge laid squarely by the U.S. Treasury but vehemently rejected by Berlin.

This complaint has long been levelled at Germany (and China) at a G20 level and now within the euro zone too. Italian Prime Minister Enrico Letta urged Berlin this week to do more to boost growth.

Stronger German demand for goods and services elsewhere in the euro zone would surely help recovery gain traction. The counter argument is that in the long-run, only by improving their own competitiveness can the likes of Spain, Italy and France hope to thrive in a globalised economy.

French travails

The Bank of France’s monthly report forecasts growth of 0.4 percent in the last three months of the year, up from an anaemic 0.1 percent in the third quarter. That still makes for a fairly doleful 2013 as a whole.

France is zooming up the euro zone’s worry list, largely because of its timid approach to labour and pension reforms. Spain has been much more aggressive and is seeing the benefits in terms of rising exports (and, admittedly, sky-high unemployment). So too has Portugal.

Tellingly, both the Iberian countries have had the outlook on their credit ratings raised to stable in recent days while S&P cut France’s rating to AA from AA+. It remains at a far stronger level but the differing directions of travel are clear.

Strongly vigilant?

An alarming drop in euro zone inflation – to 0.7 percent from 1.1 percent – throws today’s European Central Bank policy meeting into very sharp relief. Not since the central bank cut interest rates in May has it been under such scrutiny.

No policy change is likely, and “sources familiar” are already talking down the threat of deflation. But the central bankers, who are mandated to target inflation at close to 2 percent, will be alarmed at the sight of price pressures evaporating. One need look no further than Japan to see the damage deflation can do, often for many years.

We reported last week that a strengthening euro has also come onto the ECB’s radar, given it could depress both growth and inflation, and that there are three camps – one wanting an interest rate cut (which we know was discussed at the last meeting), another preferring to keep the option open of another long-term liquidity flood for the banking system as was done last year, and a third wanting to do nothing.

Take-off has been delayed

Euro zone services PMIs and German industry orders data will offer the latest snapshot of the currency bloc’s economy which the European Commission now forecasts will contract by 0.4 percent this year and grow just 1.1 percent in 2014 – hardly escape velocity, in fact barely taxiing along the runway.

We know from flash readings for the euro zone and Germany that service activity expanded but at a slower rate last month. France’s reading crept back into expansionary territory for the first time since early 2012. Any revisions to those figures will be marginal leaving the focus more on Italy and Spain for which we get no preliminary release.

Italy’s service sector has been growing of late, according to the PMIs, while Spain’s has still been shrinking though at a slower pace. German industry orders posted a surprise 0.3 percent drop in August and are forecast to have grown by 0.5 percent in September.

What’s happened to euro inflation?

New European Commission macro forecasts for the euro zone and the EU have been given added significance by an alarming drop in inflation to 0.7 percent which has heaped pressure on the European Central Bank to ward off any threat of deflation.

There are myriad other questions – Will the Commission predict that Italy will miss its deficit target? What will it say to those countries in bailout programmes – particularly Greece, where the troika returns for a bailout review today, and Portugal? And what about France’s sluggish economy? PMI surveys on Monday showed it is acting as a drag on the euro zone recovery.

Against that backdrop, European Commission President Jose Manuel Barroso will speak at Frankfurt’s St. Paul’s Church, the seat of the first democratically elected parliament in Germany. He is expected to outline the political priorities of the European Union in the months to come and spell out his expectations of a new German government.

It’s all Greek

The EU/IMF/ECB troika is due to return to Athens to resume a review of Greece’s bailout after some sparring over budget measures.

Greece’s president and prime minister have said they will not impose any further austerity measures and hope that their ability to run a primary surplus will persuade its lenders to cut it some more slack on its bailout loans to make its debt sustainable. The EU and IMF say there will be a fiscal gap next year that must be filled by domestic measures, be they further wage and pension cuts or tax increases.

We had a round of brinkmanship last week with EU officials saying they weren’t going to turn up because Athens had not come up with plausible ways to fill a 2 billion euros hole in its 2014 budget. But on Saturday, the European Commission said the review was back on after the Greek government came up with fresh proposals.

Italy versus Spain

Italy will auction up to 6 billion euros of five- and 10-year bonds after two earlier sales this week saw two-year and six-month yields drop to the lowest level in six months. Don’t be lulled into thinking all is well.

After Silvio Berlusconi’s failure to pull down the government, Prime Minister Enrico Letta has some time to push through economic reforms, cut taxes and spending. But already the politics look difficult and the central bank said yesterday that government forecasts for 1.1 percent growth next year and falling borrowing costs were overly optimistic.

Bank of Italy Governor Ignazio Visco and Economy Minister Fabrizio Saccomanni will speak during the day.

Spanish sums

Spanish third quarter GDP figures tomorrow are likely to confirm the Bank of Spain’s prediction that the euro zone’s fourth largest economy has finally put nine quarters of contraction behind it, albeit with growth of just 0.1 percent.

Today, we get some appetizers that show just how far an economy with unemployment in excess of 25 percent has to go. Spanish retail sales, just out, have fallen every month for 39 months after posting a 2.2 percent year-on-year fall in September, showing domestic demand remains deeply depressed. All the progress so far has come on the export side of the balance sheet.

Spain’s public deficit figures, not including local governments and town halls, are also on the block. The deficit was 4.52 percent of GDP in the year to July and the government, which is aiming for a 6.5 percent year-end target, says it is on track.

The Italian Job

Italy has dropped out of the spotlight a little following the protracted political soap opera surrounding Silvio Berlusconi. But it remains perhaps the euro zone’s most dangerous flashpoint.

Prime Minister Enrico Letta now has some time to push through economic reforms, cut taxes and spending in an effort to galvanize activity. But already the politics look difficult.

Italy’s three main unions are to strike over the government’s 2014 budget plan. Former premier Mario Monti resigned as head of his centrist party after it supported the budget which he viewed as way too modest, lacking in meaningful tax cuts and deregulation.