Eurozone Economic Boom Confirmed, but German Inflation Data Takes the Shine off the Euro

Eurozone GDP data confirms the area's boom continues, but German inflation takes the shine off a day off good data for the Euro.

The Eurozone economy slowed a touch in the final quarter of the year, according to Eurostat data released Tuesday, but 2017 overall saw the currency bloc experience its strongest rate of growth since 2011.

Eurozone GDP grew by 0.6% during the fourth quarter, which is in line with the economist estimate for growth but down from the 0.7% pace of expansion seen in the three months to the end of September.

This made for an overall growth rate of 2.5% during the 2017 year as a whole, which is up from the 1.8% pace of growth seen back in 2016 and makes for the strongest expansion since the debt crisis that began in earnest during 2011.

“Euro-zone GDP growth continued at a healthy pace in Q4 and, while the EC’s Economic Sentiment Indicator (ESI) declined in January, it continues to point to a pick-up in growth to come,” says Stephen Brown, a European economist at Capital Economics. “While there is no detail in this release, the breakdown for France suggests that growth was broad-based.”

Separate, other data released Tuesday showed France contributing notably to the Eurozone upturn during the fourth quarter, with the economy growing by 0.6% during the period.

This strong recovery of the Eurozone economy has already prompted the European Central Bank to begin the process of winding down its crisis-era quantitative easing programme; something that has contributed to the multi-month surge in the value of the Euro.

However, expectations for a rapid exit from quantitative easing were pared back somewhat following the release of inflation data from Germany.

German month-on-month CPI for January read at -0.7%, worse than the -0.6% forecast by economists. The annualised figure read at 1.6%, less than the 1.7%.

The below-consensus numbers serve as a reminder just why the ECB warned at their January meeting that they will maintain a slow-and-steady approach to ending their quantitative easing programme amidst concerns that inflation in the Eurozone is not yet where they would like it to be, partly thanks to the rising value of the Euro having a dampening effect on price pressures.

"German CPI miss taking some shine off the Euro - if this translates to EZ core CPI missing, where does it leave the data-dependent ECB?" asks Neil Wilson at ETX Capital.

The Bank reduced the amount of Eurozone bonds it buys each month from €60 billion to €30 billion this January and markets have been hoping that it will cease buying bonds completely some time in 2018 - if the date is pushed back further expect the Euro to struggle.

The ECB said in October that the program will continue until September “or beyond”, from which point markets will turn their attention back to Eurozone interest rates and the question of how soon an initial increase can be expected.

“Rising inflation expectations further increase the chance that the ECB will bring its asset purchases to an end this year, but the fact that expectations point to core inflation rising to just 1.5% suggests that interest rate hikes are a long way off,” says Capital Economics’ Brown.

Developments around Eurozone inflation will therefore be important for determining when the ECB will move to wind down its QE program.

For all of the upturn in Eurozone growth, inflation remains stubbornly below the ECB’s 2% target and wage pressures are still missing in action.

Headline inflation fell back to 1.4% in the Eurozone during December while core inflation, which removes volatile commodity items from the goods basket, remained static at 0.9%.

"At this stage, the impact of strong growth and rapidly falling unemployment on the ECB’s thinking is still being counterbalanced by weak news on underlying inflation," says Greg Fuzesi, a Euro area economist at J.P. Morgan.

ECB chief Mario Draghi said last week there are still “no convincing signs of a sustained upward trend” in inflation and that there are “very few chances at all” of an interest rate rise at the end of the 2018 year.

Some commentators had taken statements around adapting the bank’s forward guidance, contained in December’s ECB minutes, to mean an interest rate rise might come around the end of 2018 rather than toward the end of 2019 - which is when markets had previously expected the ECB to change rates.

Many economists are still doubtful that wage pressures can become significant enough in the Euro area to support a sustainable return of inflation toward its target in the short term. This in part because of the still-high unemployment rate of 8.7%.

Minutes from the ECB’s December meeting showed policy makers taking heart from signs that some wage pressures may be beginning to build in the Eurozone, although private sector economists are still reluctant to get excited.

“With “initial signs of an uptick in wage pressures,” the ECB is referring to the annual growth of compensation per employee,” Fuzesi notes.

“However the evidence on this is somewhat tentative. Only France has seen a clear pickup in the growth of compensation per employee from around 1%oya in 2015 to 2.1% in 3Q17. In contrast, Germany has seen some pickup since early 2016, but this only puts its wage growth back to where it was in 2015.”

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