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Europe takes a breather as economic growth slows

The eurozone’s strong economic recovery was one of the unexpected good news stories of 2017. But the pace of growth has slowed.

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Spain: insulated from the strong euro

The eurozone's strong economic recovery was one of the unexpected good news stories of 2017. "Economists are worried this year could deliver a much less desirable surprise," says Claire Jones in the Financial Times.

Recent surveys, especially in Germany, which accounts for around 30% of the bloc's output, have disappointed analysts. Germany's ZEW indicator of economic sentiment has slipped to a five-year low. German industrial production slipped sharply in February, and Europe-wide car sales were 5.3% down year-on-year in March. The widely watched PMI composite gauge, which tracks both manufacturing and services, has slipped in the first quarter.

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"The bottom line is that the acceleration of the eurozone economy has stopped," as Florian Hense of Berenberg Bank told the FT. However, for now it looks as though growth will settle into a slower, but still robust pace rather than embark on a downturn. This week it emerged that the PMI stayed steady in April. It is some way below January's near 12-year high, says Capital Economics, but it has "stopped the rot". It is strong enough to be consistent with quarterly growth of 0.5%.

In Germany, the quarterly pace of growth has slowed marginally, but "we remain fairly optimistic" about German growth, not least because the new government is about to loosen fiscal policy. Note, too, that with GDP only up by 10% in the past decade, unemployment still relatively high and investment still depressed, there is plenty of spare capacity that should allow the recovery to continue. Expect growth of around 2.3% this year after last year's 2.5%.

Currency drags on exporters

Europe is much more geared to global growth than the US or Britain thanks to its large export sector, so the prospect of a trade war would undermine investor sentiment. The strengthening euro is also a concern in this regard. It has climbed by 8% on a trade-weighted basis (against a basket of trading partners' currencies) in the past year, and is at a three-year high against the dollar. However, the currency's drag on exporters' earnings and overall corporate profits will be offset by healthy global and domestic growth. During the euro crisis, the weak single currency was not significant enough to give earnings a boost.

Nonetheless, note that the periphery tends to outperform when the euro is strong, as its stockmarkets tend to be less globally orientated, saysJustina Lee on Bloomberg. Roughly 56% of Spain's market value stems from domestic sectors, compared with 15% in France, according to Credit Suisse research. So while Europe's rally looks set to continue, the southern countries may outpace the north in the months ahead.

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