EUR/USD: German Industrial Slowdown Places Question Mark Over Eurozone Growth Outlook

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- German industrial production posts surprise fall in August. 

- Threatens outlook for third-quarter and 2018 economic growth.

- Extent of one-off influences is unknown but data bearish for EUR.

The Euro outlook may have dimmed a touch further Monday after official data revealed a surprise fall in German industrial production during August, which has placed a question mark over the likely pace of growth in the Eurozone's largest economy during the third-quarter and for the year overall. 

German industrial production declined by -0.3% during August, deepening an upwardly-revised decline of -1.3% seen back in July, when markets had been looking for output from the nation's factor sector to have rebounded by 0.4%. 

Annual growth was also negative in August, with output from the sector -0.1% lower this year than it was during the same month of 2017.

Production growth of consumer and intermediate goods was positive during the most recent month with capital goods manufacturing bearing the brunt of the slowdown in the sector. 

"Today’s decline of the capital goods sector is a continuation of last month’s WLTP effect (Worldwide Harmonized Light-Duty Vehicle Test Procedure), which affected the German auto industry and already dragged down the headline reading in July," says Dr. Thomas Strobel, an economist at UniCredit. "Given that this effect represents a temporary effect rather than a fundamental issue, it will not have a long-term impact. At this stage it is not clear when exactly the rebound will kick in."

UniCredit's Strobel says August's fall in industrial production is the result of one-off declines in activity within the automotive sector, emanating from European Union changes to emissions testing rules, that will not be repeated. 

However, others are less optimistic because two economists at separate firms are saying the data will have an impact on third quarter growth, as well as the German economic expansion for 2018 overall. 

"August's 0.3% fall in German industrial production is much weaker than expected and suggests that the economy is very unlikely to match Q2's 0.5% expansion in the third quarter. The decline follows a 1.3% fall in July and is a particular disappointment after the strong rise in industrial orders data released last week," says Jennifer McKeown, chief European economist at Capital Economics. 

McKeown says industrial production will not return to the level it saw last year and that her earlier forecast for German GDP growth of "a little more than 2%" now looks optimistic. German GDP grew by 0.3% in the first quarter and by 0.5% in the second quarter.  

The Euro-to-Dollar rate was quoted 0.35% lower at 1.1475 following although the Euro-to-Pound rate was 0.17% higher at 0.88783 making for a Pound-to-Euro rate of 1.1379.

McKeown's forecast is a problem for the Euro because any loss of economic momentum in the Eurozone might undermine the already-feeble inflation pressures present in the bloc's economy.

After all, the single currency's appeal to investors is hinged largely upon expectations the European Central Bank (ECB) will end its quantitative easing programme this year and begin raising interest rate some time in 2019. 

However, the ECB might struggle to justify raising interest rates next year if the inflation picture does not improve considerably over coming quarters. 

"This points to downside risks to GDP growth after a solid 0.5% rise in Q2," chimes Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics. "But unless factory orders slow further, which we doubt, output growth shouldn’t weaken from here, a signal which is consistent with the survey data at the end of Q3." 

The European Central Bank has been fighting against below-target inflation and weakening price pressures ever since the middle of 2012. It is mandated to use monetary policy to ensure inflation remains "close to but below 2%". 

Eurozone CPI fell from 2.7% in September 2012 to a low of -0.6% in January 2015. It has since risen back to 2% on a number of occasions, notably in March and April 2017, only to go once again into retreat immediately after.

Core inflation, which removes commodity items from the goods basket and so is thought to provide a better reflection of domestically generated price pressures, has never made it above 1.2% in all that time. 

Inflation rose by 2.1% during September 2018, up from 2% previously, which reverses the 10 basis point decline seen back in August. 

But core inflation, the truer measure of price pressures, posted a surprise 20 basis point fall to a five-month low of just 0.9%.

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

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