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Economics: Eurozone Economics – Markets – Strategy EZ: ECB eyes wages • 1Q08 GDP surprised on the upside thanks to investment growth. Exconstruction GDP grew by 2.8% (QoQ, saar) • Going forward, consumption should recover due to higher wages and help keep growth near potential ( ~2%) in 2008 and probably in 2009 as well • As consumption recovers and export growth remains healthy, high capacity utilisation rates should support investment spending • Euro strength has been a positive thus far, helping to curb imported supplyside inflation. It has also supported Eurozone’s nominal USD import demand and hence global growth in the face of US slowdown • We expect one rate hike in Jul08. Wage developments are central to the growth, inflation and interest rate outlook 1Q08 GDP exconstruction grew by 0.7% (QoQ, sa) or 2.8% (saar) 1Q08 GDP review and summary outlook 1Q08 growth surprised on the upside at 0.8% (QoQ, sa) or 3.2% (QoQ, saar), led by a surge in investment (10.7%). While temporary factors, such as mild weather in Europe, pushed construction spending higher, ex-construction GDP also grew by 0.7% (QoQ, sa) or 2.8% annualised. This reflects largely the strength of business investment spending. Consumption spending recovered slightly from 4Q07 but remained subdued (0.6%). Going forward, investment growth should moderate and consumption should pick up slowly and steadily in line with higher wages. This implies that overall GDP growth should stay around potential. We continue to look for 2% GDP growth in 2008 and 2009 (Chart 1 &2). Both growth and inflation uncertainties remain high. Insufficient real wage growth, further rise in commodity prices and higher interest rates are the main downside risks to growth. While inflation risks lie to the upside, in the policy relevant time horizon (18-24 months), we think inflation risks are not material. EUROZONE Chart 1: GDP growth - around potential %, YoY, annual data 6 5 4 3 2 Potential GDP 1 0 -1 1992 1994 1996 1998 2000 2002 2004 2006 2008F Chart 2: Contributions to GDP growth %-pts, QoQ, saar 4 3 2 1 0 -1 -2 Mar-04 Mar-06 Mar-08 Pvt Consmptn Invst exp GDP DBS F'cast Govt exp Net Exports Ramya Suryanarayanan • (65) 6878 5282 • ramya@dbs.com 148
Economics – Markets – Strategy Economics: Eurozone Consumption supported by strong labour market While higher food and fuel prices have hurt sentiment and demand in 4Q07 and 1Q08, sentiment is still better than average 2000-07 levels, and even above 2004 level. Both periods saw average quarterly growth of 1.5% in consumption (QoQ, smoothed). A comparison of US and Eurozone consumer confidence also shows that while both indices are falling, Eurozone’s index is still at elevated levels (Chart 3). Importantly, the labour market is still supportive of wages, and unemployment is at decade lows (Chart 4). High level of unionisation of labour also supports wage growth in the face of rising prices. In Germany, for example, wage negotiations concluded thus far have ended with circa 5% rise in wages in 2008. This is well above the 3% average inflation expected in 2008. As such, we are comfortable with our forecast for 1.1% (QoQ, saar) and 1.5% quarterly consumption growth in 2008 and 2009. Consumption should pick up with higher wages keeping growth near potential Chart 3: Consumer confidence Chart 4: Unemployment to stay at decade lows EZ Index 5 0 -5 -10 EZ (LHS) 2000-07 avg (EZ:-10, US:90) US (RHS) US Index 119 109 99 89 %, sa 11 10 9 -15 79 8 -20 69 Latest: May08 -25 59 May-00 May-02 May-04 May-06 May-08 7 Latest: Apr08 6 Jan-93 Jan-97 Jan-01 Jan-05 Jan-09 Investment - consumption pick up and capacity utilisation support As consumption recovers and remains supportive of growth, the elevated levels of capacity utilisation should drive investment spending (Chart 5). Despite falling sharply, the business climate index remains above average of 2005 and 2000-07 Chart 5: Capacity utilisation vs investment spending % % YoY 86 10 Chart 6: Business climate - better than 2004/05 Index 2 84 6 1 2000-07 avg (~ 0.13) 82 2 0 80 -2 78 76 Capacity Utilisation GCF % (RHS) Mar-93 Mar-98 Mar-03 Mar-08 -6 -10 -1 Latest: May08 -2 May-00 May-02 May-04 May-06 May-08 149
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