It was all going so well. Leading indicators suggested a strong recovery for Europe’s beleaguered economy as it emerged from lockdown.
Economists started hoping that recovery might look more like a ‘V’, rather than a ‘L’.
But new data suggests the recovery is losing momentum already.
Short-lived rebound
After a dismal second quarter when the Eurozone economy contracted by a record 12.1%, it had seemed that the region was rebounding.
The IHS manufacturing Purchasing Managers’ Index (PMI) jumped to 51.8 in July, up from 47.4 in June.
This was the first time it had been above the 50 mark (separating growth from contraction) since January.
Services PMI rose to 54.7 from 48.3, its highest level since September 2018.
However, increasingly, this looks like a short-lived bounce-back in demand rather than a genuine self-sustaining recovery.
Equivalent PMI numbers for July look notably weaker.
The flash IHS Markit Eurozone Composite PMI posted 51.6 in August, down from July’s reading of 54.9.
Steven Bell, chief economist at BMO GAM, says: “PMI numbers have fallen back, suggesting that after an initial surge of pent-up demand as lock-downs eased, the pace of recovery has slowed.”
Too soon to judge?
Rose Thomas, portfolio manager for macro strategies at JP Morgan Investment Funds, takes a more optimistic view: “PMIs have been recovering to levels comfortably above 50. Retail sales are above pre-virus levels. Industrial activity is seeing incremental improvement.
“Our macro framework sees Europe as firmly in recovery and some growth signals are even moving towards expansion.”
It may be that the recovery cannot be judged in aggregate.
For example, the German economy has been ticking along nicely. Well-watched data from the Ifo Institute in Munich showed that business sentiment had become “markedly more positive” in August, with the index score rising from 90.4 in July to 92.6 in August.
This is in contrast to economies such as Spain, where rising Covid-19 cases have hit the all-important tourism and leisure sectors.
Thomas says that they are keeping an eye on the second wave and admits it may impact recovery: “We have seen some resurgence in the virus over the last few weeks, particularly in Spain and France.
“We’re monitoring the rise and also the response from authorities. This has so far been targeted, responding to localised incidences. We will monitor how this might impact the recovery in the coming weeks and months.”
Fuzzy figures
Ultimately, it is still difficult to judge the level of unemployment across the Eurozone.
Wealthier countries such as Germany have been able to extend their equivalent of the furlough scheme to keep people in work, but this is not an option for nations with higher debt.
Italy, for example, has had to go cap in hand to the European Union’s SURE unemployment scheme for €28.5bn to extend its employment support.
Unemployment levels – and related economic confidence and spending levels – are likely to determine the long-term strength of the economic recovery.
The other big white hope for European governments is the EU recovery plan.
It is big enough to make a significant difference to individual economies: the Economist recently estimated that the Italian share of the fund amounts to around 4.3% of its GDP.
It remains largely unspent and therefore its impact is yet to be quantified. The plan comes with caveats and is likely to benefit some sectors of the Eurozone economy over others.
What does it mean for European assets?
Both realised inflation and inflation expectations remain below the 2% target level.
This means monetary support is likely to continue for some time.
However, it is difficult to see yields compressing further from here whatever happens to the Eurozone economy.
At the same time, Bell believes if there is a vaccine, quantitative easing measures are likely to be pared back relatively quickly. “This would suggest low government bond yields have a time stamp on them.”
At the same time, growth also appears patchy and elusive.
Net government debt to GDP has risen and is expected to rise further, which may also slow growth.
This means equities don’t have much of a tailwind.
That said, while the MSCI Europe has slightly outperformed the MSCI World over the past three months (13.2% versus 12.9%), there aren’t significant recovery expectations baked into European equity prices.
Thomas at JP Morgan remains positive on European equities in the group’s multi-asset portfolios.
The European recovery has lost momentum, but there is a lot still to play for. Some sectors of the Eurozone economy are reviving and the EU Recovery fund could still provide a significant stimulus.
Unemployment remains the main wild card.
