Interactive Investor

Eurozone and UK on diverging economic paths

22nd September 2017 17:13

Emil Ahmad from interactive investor

There was a time when former prime minister David Cameron thought in terms of a "two-speed Europe". Prior to the game changer known as Brexit, it would have been hard to argue with his optimism.

Why would the UK want to fully commit itself to a Europe that could be on the brink of collapse? Far better to renegotiate its position within Europe and cement its position at the top table on better terms.

Fast forward a couple of years and positions have been reversed. If a different type of two-speed Europe was put into practice today, there is little doubt that the UK would be firmly rooted in the slow lane in economic terms.

While most of Europe is enjoying an economic renaissance, the UK is failing to shake off its post-Brexit hangover. As former Monetary Policy Committee member David Blanchflower observed over the summer, the UK is quickly becoming "…the sick man of Europe".

Life in the slower lane

Office for National Statistics (ONS) figures suggest business here is hardly booming. Q2 economic growth this year was 0.3%, a very slight improvement on the 0.2% increase during the January to March period. When one considers that GDP growth was 0.7% in Q4 2016, it is clear that the fog of Brexit uncertainty is growing ever thicker.

Aberdeen Asset Management chief economist Lucy O'Carroll noted in the press in July that this pick-up in Q2 growth was of little significance. O’Carroll is more focused on the overall macro outlook.

"It's the underlying trends that matter. They don't look favourable at the moment, given the uncertainties around Brexit and the pressure on household budgets from higher inflation."

The High Street is acutely aware of this squeeze on household budgets. Further ONS data indicates that Q2 household spending increased at its slowest level since 2014, growing by a paltry 0.1%.

Weakness in manufacturing and construction provided a further impediment to growth over the quarter. Despite consistently maintaining some degree of GDP growth since 2013, the UK is the worst economic performer amongst G7 nations in 2017.

The re-emergence of the eurozone

While the UK continues along its faltering path, it would appear that GDP growth within the eurozone has gained some serious momentum. The 19 member states of this monetary union enjoyed Q2 growth of 0.6%, a rate of expansion twice as fast as the UK over the same period.

Official data from Eurostat showed year-on-year growth of 2.1%, an increase of 0.2%. This represents the best performance from the euro area in five years.

As geopolitical risk faded into the background, the reinvigorated economic health of the bloc has stunned critics.As the market digested the Macron effect and electoral setbacks for populist parties in Austria and the Netherlands, a wave of optimism has swept across the region.

This has provided a significant boost to consumer and business confidence, with the euro area enjoying economic growth for 17 consecutive quarters. There even appears to be some respite from the unemployment problem endured by the bloc’s most vulnerable members. Unemployment for the euro area hit an eight-year low of 9.1% in June.

Data released in September from financial information company IHS Markit supports this ongoing European feel-good factor. The company's purchasing managers' index remained constant at 55.7 points in August. This index acts as a broad measure of economic activity with any rating over 50 indicating expansion.

Although output growth since July is slightly down on a quarter-on-quarter basis, the firm indicated that the eurozone is on target for GDP growth of 2.1% in 2017. Although this level of growth was achieved in 2010, better levels of economic prosperity have not been witnessed by the bloc since 2007.

Optimism is reinforced by official measures of economic sentiment. The European Commission’s Economic Sentiment Indicator (ESI) reached 111.9 last month, a 0.6 gain on July’s figure of 111.3. This level was last exceeded in July 2007, the month before what is universally regarded as the start of the financial crisis.

This has been reflected at a country level, with the official measure of economic confidence in Italy almost reaching a 10-year high. Germany’s equivalent measure produced by the Institute for Economic Research surpassed record highs once again last week.

Historical ESI chart for the euro area and EU

So, it would appear that the UK and the euro area are on diverging economic paths. As Brexit negotiations become increasingly convoluted, the political and economic certainty that will reinvigorate a faltering UK is a worryingly distant prospect. While the eurozone is apparently thriving, there’s reason to be cautiously optimistic about its prospects.

That said, GDP growth is slightly more subdued than some highly bullish measures of confidence would indicate. There is also the question of QE. The European Central Bank’s (ECB) asset purchase programme is due to end in four months and this withdrawal of economic stimulus will need to be carefully managed.

The ECB is set to formalise this tapering process in October with room to manoeuvre limited by bond scarcity. Expectations surrounding future monetary policy could impact the region’s ongoing recovery and a surging Euro complicates this difficult balancing act even further.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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