Recent eurozone data flow has been poor, and the coronavirus outbreak presents an additional downside risk to the eurozone.
We revise our Q1 forecast down from 1.13 to 1.09 to reflect these factors. However, the underlying consumer side of the economy remains strong, and the bar for further easing by the European Central Bank seems to be set high.
Conditioned on our base-case assumption that the coronavirus is a sharp but brief shock, the global external demand picture should improve for the eurozone as a whole through to the end of the year, improving the bloc’s growth prospects.
As a result, we remain relatively optimistic about the euro’s prospects through to the end of the year.
Chart: EURUSD plummets on virus fears in Q1 2020
Data picture worsens – but on the whole, a recovery is likely in 2020
Macro data released in January and February has on the whole supported our base case view that the eurozone economies have likely seen the bottom of the manufacturing-led slowdown of 2019.
A large divergence remains between manufacturing and non-manufacturing sector output, the latter of which crashed in the second half of 2019. Services survey data indicates sustained output growth while manufacturing surveys point towards a modest improvement after the sustained falls seen in Q4.
The notable exception to this has been data from Germany, which has pointed to continued downside risks, particularly in the manufacturing sector.
M1 money supply growth, a leading indicator, was stable in Q4, suggesting the manufacturing slowdown did not result in a broad fall in aggregate demand. Looking at these and other factors, on balance we think the gap between services as manufacturing will be closed by an improvement in manufacturing, and not a decline in services over the course of 2020.
The ECB is likely to remain a non-factor for the euro in Q1
January’s ECB meeting made two important points clear:
- Firstly, the bar for further easing is set very high, and the stabilisation in macro data seen in December means no further policy easing is likely unless the eurozone economy takes a sudden and unforeseen turn for the worse.
- Secondly, the ECB’s policy review will include broad consideration of the inflation targeting framework, as well as the ECB’s role in climate change policy.
In light of the generally optimistic tone of the ECB’s January meeting and serious opposition to the last expansion in easing, the ECB is likely to avoid any “insurance cuts” driven purely by the recent series of poor data in Germany and the risk of the coronavirus outbreak.
We note that other central banks, for example, the Reserve Bank of Australia and the Reserve Bank of New Zealand have both been willing to assume the outbreak will prove a transitory shock.
The ECB’s policy review could prove relevant for the euro. A move towards a formally symmetric inflation target or average inflation targeting would be a structurally dovish change to the central bank’s reaction function. Climate change may remain an academic topic, but will also have market relevance if it becomes a possible back door towards the issuance of eurozone bonds eligible for future ECB purchases.
Two tail risks have developed in January for the euro…
Coronavirus outbreak: the Wuhan coronavirus outbreak will slow Chinese GDP by a significant but unknown amount in the first quarter. This will have a knock-on effect on global growth, presenting a clear downside risk for the eurozone due to the area’s reliance on external demand. At this point the duration of the epidemic is unknown, but our base case is containment at some point by Q2, comparable with the duration of the 2003 SARS outbreak. A longer outbreak, or a global pandemic, will slow global growth and affect all our FX views.
US-EU trade deal: stalled talks on a trade deal between the US and EU present a risk that the Union may become a target for the Trump administration’s next trade war. Speaking at the World Economic Forum in Davos, the US President used rhetoric similar to the beginning of the US-China and US-NAFTA trade disputes, threatening “very high tariffs on [the EU’s] cars and other things”.
Chart: Eurozone surveys suggest improvement.
The coronavirus shock however is yet to be seen in survey data.
Author: Ranko Berich, Head of Market Analysis at Monex Europe.