If you expect to get hit on the head twice and you get hit twice, you might be grateful that it wasn’t more. But if you are only hit once, that’s a good outcome.
This is how financial markets often look at, and react to, economic data. If a particular data release is better or worse than the consensus forecast of the market, bonds, stocks and currencies will move according to those expectations rather than what the data are actually telling them about the economy.
Last night's release of the eurozone GDP result for the June quarter was a bit like getting hit on the head twice. Eurozone GDP fell 0.2 per cent which was broadly as expected. Because it was not worse, markets reacted calmly with most major Eurozone stock markets rising by between 0.5 per cent to 1.0 per cent and the Euro was little changed.
Taking a step back from market expectations and it is clear that the eurozone economy is performing very poorly with the recession rolling on and on and on. This is bad news for the world. According to IMF data, the 17 countries that make up the eurozone account for 25 per cent of global GDP, making it the biggest global economic bloc in the world – some 15 per cent larger than the US and 140 per cent larger than the third largest economy, China.
While markets were relatively sanguine about the eurozone GDP data because it was no worse than expectations, the fact remains that the eurozone recession is protracted with few if any signs of it coming to an end. Policy makers are still bickering about what form of monetary stimulus measures are needed. The European Central Bank is too slow to cut interest rates further and it will be has a mental block when it comes to implementing a further round of much needed quantitative easing. Given the extreme fiscal austerity measures in the most member countries, the prospects for economic recovery are slim.
A recessed eurozone economy spells problems for China. Europe is the largest export market for Chinese manufactured goods and clearly the weaker the eurozone, the more problems there will be for Chinese exporters and the Chinese economy more generally.
Already, the Chinese economy is slowing. So far, the deceleration in growth is not severe, but with more negativity from the eurozone and probably the US, China’s GDP growth may well slow to 7 per cent or in a worst case less.
This is how the eurozone recession will have its greatest impact on Australia.
Australia’s direct trade flows to Europe are relatively small. The recession in Europe will impact Australia via our massive trade exposure to China, not directly through trade flows with Europe. As the eurozone recession continues, the Chinese economy is likely to slow further, meaning Chinese demand for raw material will slow, meaning downside risks to commodity prices and Australia’s export volumes.
Already, commodity prices are weakening. Iron ore and coal prices have fallen by between 15 and 30 per cent in recent months. Copper prices have also fallen by around 15 per cent and show no signs of turning higher. This rounds out a picture which shows how the eurozone recession is leeching through the global economy and impacting on Australia.
The eurozone recession is showing up in the unemployment rate which in June, reached a record 11.2 per cent. This rate, incidently, is one that Australia has not seen since the 1930s Great Depression. That’s how grim things are in Europe.
Looking forward, the leading economic indicators make for grim reading. The Conference Board Leading Economic Index for the euro area fell 0.3 per cent in June after falling 0.3 per cent in May and dropping a hefty 1.0 per cent in April. While the Leading Index is still well above the lows reached during the depths of the global financial crisis, the persistent weakness in recent months spells at least another six months of recession.
It is not clear how and when the eurozone will register a meaningful economic pick-up. All levers of policy are hamstrung and the appetite for microeconomic adjustments is low. While ever the eurozone is weak, there is likely to be a dampening inflation on commodity prices and through that, the Australian economy will be under pressure.