Europe returns to (slow) growth

Europe returns to (slow) growth

Europe’s economy seems to have turned the corner. In the first quarter of this year, the economy expanded by 0.3%, the strongest reading in a year and enough to lift the region out of recession. This doesn’t look like a flash in the pan. Economists expect the EU to keep growing this year and through next.

• With inflation down to 2.4% in April and underlying or core inflation running well below US and UK levels, the European Central Bank is likely to be the first major central bank to cut interest rates. Markets ascribe a 93% probability to the ECB reducing rates when they meet on 6 June.

• A return to growth ends a miserable period for Europe. The pandemic, soaring inflation and the energy crisis have hit the region hard. Excluding Ireland, whose GDP data are flattered by the treatment of multinational companies’ profits, the EU economy is only 3.0% larger than it was in 2019. Over the same period the US economy has grown by 9.0%.

• American economic outperformance against Europe long predates the pandemic. Among economists’ optimism about Europe’s recovery is tempered by worries about the region’s long-term growth prospects. This came through to me last week at a conference of US and European economists held at the Bundesbank in Hamburg.

• In some respects the mood of optimism about the US economy reminded me of the near-euphoria about US growth prospects during the dot.com boom of the late 1990s. Speakers cited a number of factors that they believe will contribute to a superior US performance over coming years.

• Cheap home-grown energy from oil, gas and renewables gives America a cost advantage over Europe. In Europe, the natural gas price is currently about four times that of the US. The average baseload cost of electricity over the last month in Europe was $73/MWh, twice what US consumers pay. Europe’s chemicals sector has been buffeted by high energy prices, with plant closures, which seem set to continue this year, and some producers shifting capacity to lower-cost countries, particularly the US.

• Government spending is fuelling the US recovery, with a vast programme designed to rebuild infrastructure and transform the semiconductors and renewables sectors. Fiscal policy is running far looser in the US than Europe, with a federal deficit forecast by the IMF at 6.5% of GDP this year compared with the euro area’s 2.9%. Crucially, the US is easing fiscal policy, further boosting growth, while the euro area is tightening.

• A number of speakers at the Hamburg conference argued that government spending, tax breaks and subsidies would reinforce America’s lead in the development and deployment of technology. It’s a big change from the consensus view 20 years ago, but my sense is that economists are warming to the sort of high-spending industrial policies, deficits and protectionism practised by the current US administration.

• Demographic factors favour the US too, with high levels of immigration and a slower pace of ageing conferring a growth advantage over Europe. The UN estimates that by 2030 America’s working-age population will have expanded by 3m people while EU’s will have shrunk by about 10m.

• The hard data paint a generally rosy picture of the health of America’s economy. Investment spending is booming, with the share of GDP accounted for by investment in the last ten years close to the highest since the war. Growth in investment, bolstered by government support, is particularly strong in manufacturing, computers and electronics. Business formation is surging. Levels of R&D spending, venture capital raised and patents far outstrip the EU. All of this bodes well for future growth – and a widening of the already sizeable gap between the US and the euro area. (The average euro area worker produces roughly 80% of what an average US worker produces in an hour.)

• There are reasons for optimism about the US, but there are also risks, of which there was less talk in Hamburg last week. The record of government intervention and industrial policy in the US is mixed. It is hard to believe it will be different this time. History and economic theory show that protectionism raises prices and weakens competition, often to the detriment of long-term growth. Easy fiscal policy, coupled with an ageing population, means US debt will soar over the next 50 years, creating a new source of vulnerability.

• That said, I would guess vanishingly few economists think Europe will even come close to match America’s growth performance over the next ten years. Europe needs new sources and drivers of growth. An obvious place to start would be by doubling down on economic integration within the EU to build a larger, more competitive market, closer to the US model.

• The 1990s and early 2000s saw rapid economic integration in Europe, with the creation of the single market and the euro and EU enlargement into central and eastern Europe. That period ended with the financial crisis. Now, with growth coming back in Europe, would be a good time to restart it.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week down 1.2% at 8,317 as higher-than-expected UK inflation dampened hopes of rate cuts this summer.

 Economics

• Early estimates of activity in May compiled from surveys of purchasing managers suggest a sharp acceleration in US activity, a modest acceleration in euro activity and a deceleration but continued growth in UK activity
• US Treasury secretary Janet Yellen called on the EU to join the US in imposing tariffs on imports of Chinese electric vehicles, saying that: “China’s industrial policy may seem remote as we sit here in this room, but if we do not respond strategically and in a united way, the viability of businesses in both our countries and around the world could be at risk”
• European Commission president Ursula von der Leyen said she was opposed to blanket tariffs on Chinese goods while German chancellor Olaf Scholz noted that “at least 50 percent of the imports of EVs from China” are European brands
• The Chicago Federal Reserve Bank Financial Conditions Index reached its most favourable level since January 2022 as bond yields and risk spreads have fallen in recent weeks. The development should support corporate borrowing and deal activity
• UK inflation fell to 2.3% in the year to April down from 3.2% the previous month but slightly ahead of expectations. Falling gas and electricity prices drove much of the decline
• More modest falls were seen in the core inflation measure and the services inflation measure of 4.2% to 3.9% and 6.0% to 5.9%, respectively, possible evidence of underlying inflationary pressure
• Investors’ expectations of an early UK rate cut declined on the news. Investors now expect no change in interest rates in June and see the first cut coming in September or November
• UK energy regulator Ofgem announced that a reduction in its price cap would mean a typical domestic fuel bill would fall by 7% to £1,568 from July. Prices are expected to rise again in October
• UK retail sales fell by a greater-than-expected 2.3% from March to April. Rainfall of 155% of normal levels was likely to be partially responsible
• UK consumer confidence saw a small rise in May to reach its highest level since December 2021. Euro area consumer confidence also rose to its highest level since February 2022
• UK net migration fell 10% to 685,000 in 2023, according to figures from the Office for National Statistics
• Applications for UK health and social care visas and visas for the dependents of students declined 25% in the first four months of the year following a tightening of rules

 Business

• Activist investor Palliser Capital called for mining company Rio Tinto, the fifth-largest company on the London Stock Exchange, to drop its London listing in favour of Sydney, claiming it was trading at a $27bn discount
• Nvidia announced $26bn in revenues in the first quarter, up 262% on the same quarter last year, as sales of artificial intelligence chips soared
• UK stockbroker Hargreaves Lansdown turned down a £4.7bn takeover offer from a consortium of private equity buyers saying it undervalued the firm
• UK retailer Marks and Spencer announced profits of £673m for last year, a 41% increase
• A UK public inquiry into infected blood products provided by the NHS between the 1970s and 1990s found significant wrongdoing and evidence of a cover-up. The government undertook to provide compensation which some estimates put at over £10bn, a material figure for the public finances

  Global and political developments

• Following the fall in inflation, UK prime minister Rishi Sunak took to the steps of Downing Street to announce a general election on 4 July
• All parties wasted little time in kickstarting their election campaigns. An average of the three polls conducted since the announcement puts the Conservatives on 23%, Labour on 45%, the Liberal Democrats on 10%, Reform on 12% and the Green Party on 5%
• Nigel Farage said he would not stand for Reform, saying that he wanted to focus on supporting Donald Trump’s presidential campaign
• Several pieces of planned UK legislation including the Renters (Reform) bill and the phased ban on sales of cigarettes were shelved due to insufficient parliamentary time
• Hungarian president Viktor Orban said he wanted to “redefine” the country’s membership of Nato. Mr Orban has opposed military aid to Ukraine and delayed sanctions against Russia
• Chief prosecutor at the International Criminal Court in the Hague, Karim Khan, applied for arrest warrants for three Hamas commanders, Israeli prime minister Benjamin Netanyahu and Israeli minister of defence Yoav Gallant on suspicion of war crimes and crimes against humanity
• Israeli and US lawmakers reacted with fury to the news with US secretary of state Anthony Blinken hinting he may support sanctions against the court
• China conducted military drills around Taiwan including mock missile strikes following the inauguration of Taiwanese president Lai Ching-te
• A helicopter carrying Iranian president Ebrahim Raisi and foreign minister Hossein Amirabdollahian crashed in poor weather, killing both. No foul play is suspected, according to state media

And finally… researchers at Cardiff University have extracted brewer’s yeast that naturally occurs in killer honeybees, from Namibia, and used it to brew a craft beer. The scientists are now looking to collaborate with a brewer to bring the unusual beer to the market – dangerous buzzness