The Eurozone is expected to confirm its initial GDP growth estimate for the third quarter on Thursday at 0.2% q/q but prior that all attention will be on the German preliminary readings (06:00 GMT) that are forecast to show that the bloc’s largest economy is in recession, probably bringing another headwind to the bleeding euro. However, it is not time to panic yet.
A recession may have been avoided in the last minute, consumption helpful too
According to forecasts, the German output declined by 0.1% in the three months to September followed by an equivalent contraction in the second quarter. Two consecutive negative quarterly prints usually define that an economy is in a downturn. Objectively, such a result should not be very surprising as the third quarter saw another exchange of tariffs between the US and China. Consequently, that may have further weighed on the German manufacturing sector that is recording its eighth-straight month in contraction according to the IHS PMI and is also suffering from new EU emission rules and probably Brexit.
Last week, a sharper decline in September’s industrial production followed by a downgrade in government’s GDP growth forecasts added fears that the export-oriented economy could be on the brink of technical recession. A few days later, though, exports and imports for the same month surged to highs not seen in more than a year, increasing speculation that a downturn may have been avoided in the third quarter in the last minute.
The healthy employment-consumption relationship could have curbed a sharper growth decline but it is still a question of how long the strength in the labor market can keep offsetting the weakness in the manufacturing sector by supporting household spending. The answer depends on the duration of the US-China trade war as well as Washington’s intention to restrict car imports from the EU.
ECB may call fiscal policy relaxation if trade progress vanishes
Recent comments from President Trump have been increasingly encouraging that a phase-one trade deal between the world’s two largest economies is possible as soon as early next month, with the sides expected to roll back some of their existing tariffs as part of the agreement. While the day and the time have yet to be set, the US president should adopt a more conciliatory behavior if he wants to close the more complicated second phase before the November 2020 elections; a closure that the stalling Chinese economy could desire even more than the US. Prior to the phase one agreement, President Trump is expected to delay tariffs on EU cars and auto parts for another six months this week, with the EU postponing its planned retaliation too as a result.
A deceleration in trade tensions and a partial removal of tariffs could reduce business uncertainty but not eliminate it as investors would like to see a full resolution of the trade problem. Nevertheless, companies could get a breather and Germany could get back some of its lost growth in coming quarters if a phase one trade deal gets finally signed.
If the sides fail to come together and new US tariffs come into effect in December, markets will be eagerly waiting to see whether the new asset purchase program and lower interest rates decided in November by the European Central Bank (ECB) are enough to provide some support to the German economy. Looking forward, there is a sense that the ECB has largely exhausted its policy toolbox and given the opposition from Germany to the new QE program, EU governments may be asked to implement fiscal stimulus to boost growth under Christine Lagarde’s ECB leadership.
German politics another dark spot
However, among other issues, the German coalition government is not united on the fiscal front. Merkel’s CDU party is still clinging on a balanced federal budget known as black zero that does not contain new borrowing, while members from its coalition SPD partner, that will declare a new leader at the end of November, have been increasingly calling to abandon that debt break. Although the political environment is expected to become noisier in the year ahead, which could delay any fiscal action, politicians are not expected to sit on their hands if conditions develop into a deeper recession.
Where next for euro?
As regards the euro currency, it could pay a price in the wake of negative GDP growth prints out of Germany. Investors, however, may not get panic yet amid rising hopes that a potential preliminary US-China trade agreement could improve business sentiment in the export-oriented economy in the coming quarters. In this case, EURUSD could retest support around 1.0992, a break of which may open the way toward 1.0966 and then to the 1.0942-1.0925 area.
Alternatively, if the economy avoids a recession, the pair could rally above the 20-period simple moving average (SMA) and hit resistance around 1.1043. If it overcomes that level, then it will likely rise towards the 1.1060- 1.1072 area.
Overall, a German technical recession could become more worrying if tensions on the trade front fail to calm in the near-term, strengthening the downfall in the euro.
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