To many, Europe is going through a much less happy version of the Ice Bucket Challenge. Recent data are sending a swift chill through markets, dampening its year-long recovery enthusiasm. It now seems that this 21 per cent of global GDP is again at risk, just another in a long list of 'serial disappointments' that have frustrated the economy's attempts at re-righting itself. It sounds daunting. Should we worry?
We'd be foolish not to be concerned. Euro Area growth slowed to a crawl in the second quarter, led by the big three continental economies. After a one-quarter respite, Italy has officially resumed a protracted recession. A flash estimate has Germany's GDP down in the second quarter. At the same time, France is flat and in political turmoil. Industrial production data is 'iffy', and confidence indicators are moving in the wrong direction.
This downturn coincides with the Russia-Ukraine conflict, and is at least partly related to the increased uncertainty and cessation of activity that have ensued in the wake of sanctions and diplomatic impasse. Moreover, the trouble has hit a zone that is still dealing with key structural weaknesses. Although improving, the banking sector still needs growth to ensure that it heals completely. The same can be said for public finances. Clearly, a growth setback poses a significant threat to not only European, but world growth.
So, do we brace ourselves for the worst, and settle in to a defensive, slow-growth strategy? Not so fast - there is reason to believe that there is still momentum. First, Europe's second-quarter setback came on the heels of a weather-related contraction in the US economy, and is possibly a delayed reaction. If so, America's stunning 4.2 per cent rebound in the April-June period could be paying Europe dividends as we speak. Solid US performance thus far in the third quarter should be a boost to Europe through year-end.
Second, business is indicating that there is pressure to invest. Second-quarter Euro-area capacity utilization resumed its upward march. It is still some distance from its previous peak, so there is no imminent danger of extremely tight industrial capacity. But businesses are increasingly concerned about looming near-term constraints, with the capacity expectations index moving quickly toward its previous peak. At the same time, the industrial orders index remained positive in the second quarter, and export volume expectations maintained a high level.
Prime causes of these looming constraints are labourers and equipment. Like other OECD economies, European businesses have seen an investment hibernation since 2009. Abundant spare capacity limited the need for new investment, and has created a very hesitant business investment mindset. At the same time, corporate cash has increased, creating the capacity to invest when the time is right. As such, Europe is poised for a potential wave of investment that will be dictated by its economic progress in the coming months.
Third, recent movements in European confidence might be negative, but the fact is that the downward movements have been modest, and both business and consumer confidence remain at relatively high levels. At -6.4%, the consumer indicator is at its fifth-highest level in the post-crisis period, and matches some of the highest pre-crisis results posted. Industrial confidence is not as strong, but is definitely healthy, and consistent with prior periods of decent investment activity.
These data are a strong indication that there has not been a complete about-face in the Eurozone, but rather a pause at a respectable level of activity and sentiment. It is too soon to conclude that recent events are aborting the nascent EU recovery. Having said that, the tentative rebound remains vulnerable to nasty shocks -- such as the Russia-Ukraine situation -- meaning that the monthly data will be watched with even more rapt attention for signs of change.
The bottom line? Hopes are high that the cold water that has been poured on Europe's recovery is just a fast ice-bucket jolt. Sort of a summer freeze that makes us feel fine.