Weakness in the euro area's core: Structural or cyclical?

The ECB’s decision in early May to cut its key policy rate to a new record low mainly reflected the deteriorating economic outlook in the euro area’s core. Today’s GDP figures provided a timely reminder of the challenges faced by these economies. Germany’s economy grew by a meagre 0.1% in Q113, against expectations for a 0.3% increase, while the contraction in Q412 was revised up by a tenth of a percentage point to -0.7%Q/Q. In France, the Netherlands and Finland, meanwhile, GDP continued to contract at the start of the year.

Prevailing weakness in the euro area’s core has different origins. With the economy close to full employment and wages rising, developments in Germany will likely prove temporary, mainly reflecting a softer-than-expected global backdrop, with exports and investment having continued to contract at the start of the year. But through its strong manufacturing base, Germany remains well positioned in the global economy, although the weaker Yen might well erode some of Germany’s much-praised price competitiveness in key export markets this year.

Weakness in other core economies, meanwhile, is of a more structural nature, and so is likely to persist throughout 2013 and possibly further ahead too. France, the Netherlands, Belgium and Finland all suffer from overheated housing markets, a marked loss in price competitiveness vis-à-vis Germany since the start of monetary union and rising unemployment. None of these developments are as threatening or destabilising as in the periphery. But they will remain a drag on growth in the near term and so raise issues for ECB policymaking.

For example, fears over a bursting housing bubble have started to suppress consumer confidence, which is at or close to euro-era record lows in France, the Netherlands and Belgium. Since 1999, property prices are up 160% in Belgium, 144% in France and 110% in Finland, more than in any of the other founding member states of the euro area. In Spain and Ireland prices rose by 170% and 160% respectively before they started falling rapidly.

In the Netherlands, meanwhile, house prices have already fallen by 17% since they peaked in mid-2008. And they are likely to fall further, according to S&P by another 6.5% by late next year. S&P also expects a “protracted correction” in French house prices, which began falling at the end of last year and are down 3.5% from their peak so far. Belgium and Finland will undoubtedly face similar adjustments in due course.

Rising house prices, meanwhile, were accompanied by ballooning bank balance sheets in some countries. Since 2003, loans for house purchases have increased by 180% in Finland and by 145% in France, compared to the euro area average of 75% (and just 9% in Germany). As in Spain and Ireland, potential house price corrections will put pressure on banks’ balance sheets and raise doubts about the quality of their assets – less so in the Netherlands and Belgium, however, where banks managed to securitize large parts of their loan portfolios, shifting risks off their balance sheets.

Despite the marked increases in mortgage loans, however, household debt in France and Finland has remained at manageable levels, at 83% and 105% of income respectively. But the situation differs in the Netherlands, where household debt rose to an eye-watering 250% of income, one of the highest levels in the world.

Where house prices have started to fall, households have responded by cutting back their expenditures. Since the beginning of 2011, private consumption has contracted by more than 3% in the Netherlands and by around 1% in Belgium and France, where it has over recent years been an important driver of growth. Only in Finland, where house prices have remained stable so far, private consumption has continued to grow.

With demand weak, job-creating investment has stagnated in France and Belgium since the start of 2011 and has collapsed by 9% in the Netherlands, where firms’ capacity utilisation is below that of Spain and close to the level seen in the midst of the global financial crisis in 2009. And despite continued consumption growth in Finland, investment there contracted by 8%Y/Y at the end of last year, the same pace as in Italy.

This is also likely to reflect, to some extent, the marked loss in price competitiveness of these economies relative to Germany. The ECB’s harmonised competitiveness indicators, based on relative unit labour costs, show that France, the Netherlands, Finland and Belgium have lost about 20% in price competitiveness vis-à-vis Germany since the launch of the euro in 1999. Lately, this has coincided with persistent and, at times, rising current account deficits in France, Finland and Belgium, while the Netherlands’ huge surplus shrank to about 8% of GDP at the end of last year from nearly 11% just a year ago.

This has gradually increased unemployment in the core, most notably in France, where the rate, at 11%, hit a 16-year high in March. But more recently job cuts have started to accelerate in other core economies too. In the Netherlands, the unemployment rate has risen from just 5% two years ago to more than 8% in March. And in Finland and Belgium unemployment crept up by 0.7ppts over the past year to just over 8%.

Weak economic growth and rising unemployment has also blown a hole in governments’ budgets. France and the Netherlands in particular are suffering from persistent high fiscal deficits and rising debt levels. Since 2007, public debt in both economies as a share of GDP has risen by nearly 30ppts, almost twice as fast as in neighbouring Germany, also reflecting the costs of past bank rescues (Fortis, Dexia, ING, SNS, etc.). And while both deficit and debt are at relatively low levels in Finland, government expenditure in the euro area’s most Northern economy stands at an unsustainable 56% of GDP, the second highest level in the euro area after France.

All of this suggests that the euro area core is likely to face a prolonged period of subdued growth or even recession. Even including Germany and Austria, the only two member states without major domestic or external imbalances, we expect the core to grow by just 0.1% this year and by 1.2% next – too slow to prevent unemployment from rising. Given its skilled labour force and traditional export-orientation – even France ran a sizeable current account surplus during most of the 1990s and early 2000s – we believe the core will be able to return to a sustainable growth path after a relatively short, albeit painful adjustment period, characterised by a gradual deleveraging of the private and public sector. Country-specific measures to restore price competitiveness, such as recent labour market reform initiatives in France, will also play a role to facilitate the return to growth. Nevertheless, given this very weak near-term outlook and to moderate the pain of the necessary adjustments, the case for further monetary easing from the ECB now appears strong.

Euro area "semi-core": Key economic dataEuro Area**% change since 2003, earliest available data. Source: Datastream and Daiwa Capital Markets Europe Ltd.


Tobias S. Blattner
Euro area Economist

Categories : 

Back to research list


This research report is produced by Daiwa Securities Co. Ltd and/or its affiliates and is distributed by Daiwa Capital Markets Europe Limited in the European Union, Iceland, Liechtenstein, Norway and Switzerland. Daiwa Capital Markets Europe Limited is authorised and regulated by the Financial Conduct Authority and is a member of the London Stock Exchange, Eurex and NYSE Liffe. Daiwa Capital Markets Europe Limited and its affiliates may, from time to time, to the extent permitted by law, participate or invest in other financing transactions with the issuers of the securities referred to herein (the “Securities”), perform services for or solicit business from such issuers, and/or have a position or effect transactions in the Securities or options thereof and/or may have acted as an underwriter during the past twelve months for the issuer of such securities. In addition, employees of Daiwa Capital Markets Europe Limited and its affiliates may have positions and effect transactions in such securities or options and may serve as Directors of such issuers. Daiwa Capital Markets Europe Limited may, to the extent permitted by applicable UK law and other applicable law or regulation, effect transactions in the Securities before this material is published to recipients.


This publication is intended for investors who are not Retail Clients in the United Kingdom within the meaning of the Rules of the FCA and should not therefore be distributed to such Retail Clients in the United Kingdom. Should you enter into investment business with Daiwa Capital Markets Europe’s affiliates outside the United Kingdom, we are obliged to advise that the protection afforded by the United Kingdom regulatory system may not apply; in particular, the benefits of the Financial Services Compensation Scheme may not be available.


Daiwa Capital Markets Europe Limited has in place organisational arrangements for the prevention and avoidance of conflicts of interest. Our conflict management policy is available at http://www.uk.daiwacm.com/about-us/corporate-governance-and-regulatory. Regulatory disclosures of investment banking relationships are available at http://www.us.daiwacm.com/.


For more details, please contact:

Grant Lewis, Economic Research
Daiwa Capital Markets Europe Limited
5 King William Street, London, EC4N 7AX

+44 (0)20 7597 8334



For up to date Research analysis, see our blog site here.

Sign up for news/events alerts