Latest PMI Masks Extent of Eurozone Growth Concerns

At first glance, the latest manufacturing growth figures for the Eurozone paints a positive picture but strip away a couple of the layers, and there is reason for concern. First, the good news – manufacturing growth as measured by the Markit Eurozone Manufacturing Purchasing Managers’ Index (PMI) rose to 58 from 57.5 in March. Any result above 50 is an indication of growth.

But now for the not-so-good news. The uptick in the Eurozone PMI is almost entirely due to strong growth in France, the Netherlands, and, in particular, Germany. Greece actually suffered a contraction while Spain was basically unchanged from March. The remaining Eurozone countries recorded positive growth for the month, but for the most part, this growth remained muted and served to underscore the growing gap between the few strong Eurozone economies and the majority that continue to under-perform.

China is the main reason for Germany’s recent success and demand for goods produced in Germany continues to build each month. Germany’s all-important auto sector especially has been on the receiving end of China’s seemingly insatiable appetite for luxury autos and has resulted in the expanding of plants and hiring of additional workers to meet demand.

Despite these gains, there is cause for a fair bit of queasiness for Germany – and by extension, the Eurozone. Keep in mind that China is facing its own challenges with stubborn inflation rates that refuse to stay within the Bank of China’s prescribed range. Indeed, even after implementing several recent interest rates hikes and forcing banks to be more restrictive when lending money, inflation continues to surge.

At some point, officials in China will be forced to incorporate even more drastic efforts to reduce expansion. Get this wrong however, and China could face a prolonged period of weak growth that will dramatically cut into demand for trade with Eurozone countries.

Challenges Facing the European Central Bank

Across the Eurozone, price inflation continues to run well above 2 percent with preliminary estimates showing a further 2.8 percent increase in April, compared to March’s 2.7 percent increase. This is adding even more to the argument supporting further interest rate hikes following the ECB’s quarter-point rate hike last month. Some estimates suggest that the central bank will be forced to implement a series of rate hikes that will see the benchmark rate jump from the current 1.25 percent to at least 2 percent by the end of the year.

The difficulty facing the ECB that it is even more evident now that the countries comprising the Eurozone are facing wildly diverging economic realities. France and Germany are likely in need of a little cooling and could withstand the slowing effect of an interest rate hike –even an appreciation of the euro following a rate increase is not likely to hurt export sales too much. The weaker Eurozone states on the other hand must be paralyzed with fright at the prospect of more rate hikes.

This is especially true for countries desperately trying to borrow money and fend off insolvency. Already, Greece and Portugal are paying heavy premiums in the face of credit rating warnings and downgrades and a rate hike will only add to these expenses. These countries are also facing higher unemployment and there is a worry that interest rates will lead to further pain in the job market. At roughly 21 percent unemployment, Spain is already struggling with unemployment nearly four times higher than Germany.

In the end, the ECB may have no choice but to place the needs of the leading economies over the weaker countries. If something is to be sacrificed, you can bet it won’t be one of the few economies actually contributing to the region’s growth.

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