European Industrial Outlook: A Two-Speed Recovery
Summary of Findings and Forecasts
- In the first half of 2015, the European economy’s business confidence strengthened. The purchasing managers’ index advanced and price pressures picked up considerably in May.
- The European Central Bank’s bond-buying program is instilling confidence that the deflationary tendencies of the previous year have been arrested. GDP is now slated to increase as much as 1.5% in 2015 and at a slightly faster pace the following year.
- Industrial output growth was running at less than a percentage point on an annual basis in April—considerably slower than during the previous two months. Europe’s industrial sector is weighed down by a lack of confidence in the success of labor and product market reforms.
- Regional growth differences persist, although they are now more pronounced in industrial sectors than in the economy as a whole. The weaker numbers mask the nascent export-led pickup in demand in mature markets such as Ireland, Sweden, Germany, and the UK as well as the Central European core.
- Our forecast has brightened for the large industrial economies of the West (except for the UK). Manufacturing growth will accelerate on the strength of rising consumer income and higher capital equipment outlays.
- The ECB’s monetary stimulus provides support to a volatile fixed income market; however, there remains the danger that a lack of support from the ECB could push Greek banks into insolvency.
- The Czech economy is returning to a robust growth phase. Activity is broadly supported, with investment demand leading the way in the wake of faster public spending funded by the EU. Overall manufacturing growth will just miss the 5% mark in 2015.
- The German manufacturing sector is taking a breather. Output stalled in the first quarter of this year as machinery production slumped and investment activity fell into a lull. The index of industrial production should still advance 2% in 2015 and faster still the following year. The computer and high-tech segment is firing on all cylinders but some nondurables, notably plastics, rubber, nonmetallics, and chemicals, are expanding at a more moderate pace.
- Spain will return to growth this year after long recessions. There has been a marginal improvement in the job market and even construction is reviving. Autos benefit from easier access to financing and stronger demand from elsewhere in Europe.
- France is growing only modestly. As always, the consumer is the strongest link, set to outperform all other components of aggregate demand aside from exports. Low capacity usage and faltering business confidence are sapping the propensity to spend on capital equipment. Industrial production might barely exceed 1% this year but accelerate toward the second half and through 2016.
Europe’s medium-term outlook calls for further strengthening in the pace of growth, absent a slump in confidence related to the Greek sovereign debt crisis. GDP jumped almost a full percentage point since our last report six months ago, though employment remains flat amid lackluster investment. Offsetting feeble capital formation has been a more accommodating fiscal stance by governments, which boosted public spending. The European Central Bank’s bond-buying program is instilling confidence that the deflationary tendencies of the previous year have been arrested. GDP is now slated to advance as much as 1.5% in 2015 and at a slightly faster pace the following year.
The manufacturing recovery seems to have stalled, however. Industrial output growth was running at less than a percentage point on an annual basis in April—considerably slower than in the previous two months. We have seen stronger demand for capital goods and consumer durables but other categories remain flat. Capital goods are receiving a boost from a less expensive euro and stronger exports while consumer durables benefited from a windfall in household budgets from lower oil prices. Sanctions imposed against Russia played some role in the slowdown, although the direct impact appears to have been small.
Europe’s industrial sector is weighed down by a lack of confidence in the success of labor and product market reforms. Companies report staying on the sidelines and not committing resources to equipment upgrades. Industrial output will advance less than 2% this year and about 2.5% in 2016.
Regional growth differences persist, although they are now more pronounced in industrial sectors than in the economy as a whole. Three groups of countries populate the distribution of GDP:
- A large cluster of emerging economies—the Czech Republic, Poland, Romania, and half a dozen other countries—are growing at rates above 3% (the first three are growing faster than 4%).
- The middle group of about 10 countries (mostly the Western European core) is growing in the 1.5-2% range.
- Finally, Finland and Greece are in recession.
The weaker numbers mask the nascent export-led pickup in demand in mature markets such as Ireland, Sweden, Germany, and the UK as well as the Central European core.
Figure 1 – Manufacturing Production in Q1 2015
Our forecast has brightened for the large industrial economies of the West (except for the UK). Manufacturing growth will accelerate on the strength of rising consumer income and higher capital equipment outlays. Output in the two smaller economies of Central Europe will stabilize following a torrid pace of expansion in 2014; the sanctions against Russia as well as rising anxiety about the fallout from the Greek crisis will dampen growth there in the next two years. Overall, the industrial sector looks better than last year because some of the pent-up demand for durables is stimulating production despite lingering concern about Greece.
Table 1 – Industrial Production Growth Rates and Forecast
There are substantial risks to this forecast. The Greek crisis has not been resolved—the political balance of power in the country remains precarious and will weigh on the confidence in the ability of the EMU to heal itself. While the sanctions against Russia have been extended, a sudden outbreak of violence in Ukraine cannot be excluded; such an event would depress business sentiment along the way across the entire EU. On the positive side, fiscal balances in many EU countries are on the mend, the danger of a deflationary spiral is receding, and the ECB’s monetary stimulus provides support to a volatile fixed income market. Finally, there remains the danger that a lack of support from the ECB could push Greek banks into insolvency.
Industries in the Current Business Cycle
In Figures 2 and 3, industrial sectors are positioned along a cyclical path divided between phases of growth and decline. Central Europe is made up of the Czech Republic, Hungary, and Poland.
- About half of the sectors in the Eurozone are still in recession. The outlook brightens somewhat for 2016.
- In Central Europe, all sectors are in expansion mode, although the stages of the expansion differ from sector to sector.
Figure 2 – Eurozone Industrial Sector by Phase of Cycle, 1st Quarter 2015
Figure 3 – Central Europe Industrial Sector by Phase of Cycle, 1st Quarter 2015
Figure 4 – Belgium: Manufacturing Production
Belgium (Figure 4)
- Belgium’s economy will not accelerate this year much above the pace of last year (1%), but GDP should advance closer to 1.5% in 2016. Consumption remains unusually subdued following the end of wage indexation schemes. Higher profit margins and rising capacity usage should spur faster investment spending, which will become the key driver of faster economic activity next year.
- The manufacturing sector slowed sharply in 2014. This year’s modest expansion will feed off continued cost control and a brighter outlook for exports. Nonetheless, sharply lower construction activity forced a downward revision to this year’s forecast to 1.3%.
- Most process industries are growing more slowly than in 2014. There’s been a faster pickup in the production of rubber, plastics, and nonmetallic products, which tend to lead in cyclical recoveries. Meanwhile, durables such as high-tech and machinery continue to suffer along with the lackluster pace of capital formation.
Figure 5 – Czech Republic: Manufacturing Production
Czech Republic (Figure 5)
- The Czech economy is returning to a robust growth phase. Activity is broadly supported, with investment demand leading the way in the wake of faster public spending funded by the EU. Consumers are back as well, buoyed by more generous pay increases. GDP is set to grow about 2.5% both this year and next.
- Industrial activity accelerated in the past two quarters. Construction remains buoyant, benefiting from public spending on infrastructure. Overall manufacturing growth will just miss the 5% mark in 2015.
- All industrial sectors are growing. The core nondurables, including chemicals, cement, and food, will underperform relative to the average. Motor vehicles and fabricated metals will advance well upward of 5% on the strength of exports and construction demand, respectively.
Figure 6 – Germany: Manufacturing Production
Germany (Figure 6)
- The German economy is growing unevenly. Performance zigzagged recently but the overall trend is up. Consumer-led expansion is now well entrenched, with housing and exports also contributing smartly. GDP might just top 2% this year—the fastest rate since 2011.
- The manufacturing sector is taking a breather. Output stalled in the first quarter of this year as machinery production slumped and investment activity fell into a lull. The index of industrial production should still advance 2% in 2015 and faster still the following year.
- Construction is a particularly bright spot. The computer and high-tech segment is firing on all cylinders but some nondurables, notably plastics, rubber, nonmetallics, and chemicals, are expanding at a more moderate pace.
Figure 7 – Spain: Manufacturing Production
Spain (Figure 7)
- Spain will return to growth this year after long recessions. With the fiscal brake no longer an issue, the expansion is now broad-based. There has been a marginal improvement in the job market and even construction is reviving. GDP is slated to advance in the range of 2.5% to 3% this year and next.
- The industrial cycle follows that of other sectors. Production growth is on course to hit the 2% mark and is headed toward 3% in 2016. Next year should see a faster pace of capital formation, strengthened by rising profits.
- The automobile and high-tech sectors lead the way, with autos benefiting from easier access to financing and stronger demand from elsewhere in Europe. There is hardly any weakness in the Spanish industrial landscape; the sector is meeting pent-up demand in the face of rising confidence that the worst of the crisis is over.
Figure 8 – France: Manufacturing Production
France (Figure 8)
- France is growing only modestly. GDP is on track to advance perhaps 1 percentage point this year. The country is vulnerable to sudden swings in sentiment as changing political winds buffet policymaking. As always, the consumer is the strongest link, set to outperform all other components of aggregate demand aside from exports.
- France's manufacturing sector is the second slowest of the “big six” economies. Low capacity usage and faltering business confidence are sapping the propensity to spend on capital equipment. Production might barely exceed 1% this year before accelerating toward the second half and through 2016.
- Slow construction activity is dragging the expansion in key support sectors, including plastics, cement, and wood. The auto segment’s production is up but there are no other pockets of strength aside from a modest pickup in fabricated metals.
Figure 9 – Italy: Manufacturing Production
taly (Figure 9)
- Italy continues to be the sick man of Europe, at least among the large economies. A more robust expansion is not forecast until 2016. In the meantime, a favorable external environment and a weaker euro should underpin exports as the sole contributor to growth.
- Manufacturing production has been contracting for several quarters now. Construction is depressed, too, as banks struggle with non-performing loans. On the other hands, there are pockets of strength, such as autos and computers.
- Industrial production is set to rise just below 1% this year, the fastest rate in four years. The broad machinery and equipment segment is particularly depressed. Investment spending is running low and will accelerate only slowly in 2016.
Figure 10 – Hungary: Manufacturing Production
Hungary (Figure 10)
- The Hungarian economy is returning to a more stable growth rate after a sharp acceleration in 2014. Faster infrastructure spending underwritten by the EU coupled with private investment buoyancy cannot be replicated this year. GDP should advance less than 3% and even lower in 2016.
- The industrial sector continues to run hot. Output might top 6%—the fastest in our peer group. Aside from the core machinery sector, hardly any other industrial segment shows weakness. Construction activity is growing in the double digits, as are motor vehicles.
- New regulations concerning redenominated mortgage terms will release additional purchasing power to consumers. Consumers will remain cautious, however, sapped by uncertainty over policy amid a rising propensity to save.
Figure 11 – Netherlands: Manufacturing Production
Netherlands (Figure 11)
- The Dutch economy is slowly emerging from a deep recession. High debt levels are stymying consumer spending and companies are reinvesting profits at a slow pace. Nonetheless, GDP is on track to expand about 1.5%, which would match the 2011 high-water mark.
- The manufacturing sector is slightly outperforming the overall economy. Industrial production is expanding slowly but should end the year almost 2% higher than in 2014. Investment spending, which has nowhere to go but up, should provide a stimulus to domestic producers.
- Construction activity continues to expand vigorously—a bright spot on the industrial landscape. The outlooks are encouraging for machinery and autos, both driven by exports. Other sectors are growing at moderate rates.
Figure 12 – Austria: Manufacturing Production
Austria (Figure 12)
- The Austrian recovery has been unusually weak compared with that of Germany, its traditional sidekick. Investment stagnates and even exports underperform. The outlook is clouded by morose business and consumer sentiment, falling tax revenues, and risks to Central Europe from the sanctions on Russia and the proximity to Ukraine.
- The industrial outlook appears somewhat brighter, but not by much. Production growth is running at about 1 percentage point annually, driven by selected durables, including electrical equipment. Nondurables, by contrast, are suffering from a depressed construction sector.
- When lower taxes kick in in 2015, consumption should take off, providing a boost to selected consumer durables. Higher demand for capital goods and improved sentiment would follow.
Figure 13 – Poland: Manufacturing Production
Poland (Figure 13)
- The Polish economy should sustain its high growth dynamics in 2015 and beyond. Conditions remain favorable for the private sector, with low inflation and interest rates while banks are loosening lending standards. GDP growth is likely to remain in the 3.5% range over the next two years.
- The manufacturing sector is poised to accelerate again. The angst over Russia’s war in Ukraine seems to have subsided and consumption is picking up. On the other hand, housing market activity is expanding only modestly despite record-low interest rates amid worries over the direction of exchange rates (many mortgages are still denominated in Swiss francs and euros).
- Not surprisingly, total industrial output is set to top 5% this year and next. Autos, computers, and machinery look solid, buttressed by an expansion in capacity. The chemicals sector, on the other hand, is undergoing a structural shift and production has been stagnating for several months.
Figure 14 – Sweden: Manufacturing Production
Sweden (Figure 14)
- Sweden is back. After a respectable recovery last year, the economy is poised to grow 2.5% this year and even faster in 2016. The contribution to growth is uneven, with consumers disproportionately underwriting robust domestic spending.
- The country’s industrial sector does not look as robust. Despite a weak krona, manufacturing output declined over the past few quarters as competitiveness sagged under the weight of steadily rising unit labor costs. Industrial production is forecast to decline this year, making Sweden the only country in our sample group with negative output.
- Construction is the sole pole of strength, underpinned by very low interest rates and high consumer sentiment. Most durables categories are in a slump despite a respectable outlook for investment spending. The turnaround in unit labor costs should materialize as early as this year.
Figure 15 – United Kingdom: Manufacturing Production
United Kingdom (Figure 15)
- Expansion in the UK is stabilizing at a rate of just under 3% this year and next. The country is one of the fastest growing economies in Europe, small or large, thanks in no small part to a prudent mix of fiscal and monetary policies.
- The industrial sector is slowing. Manufacturing output will not slide into a recession but its growth rate will be close to half of last year’s 3.1% gain. The pound sterling has strengthened at the expense of the euro while costs have increased, denting some of the advantages of the British sector.
- Aside from petroleum, which has been in secular decline for years, there are few weak spots but also few very strong performers across the spectrum of industries. Cement, ceramics, wood, and other construction materials are doing especially well, as the housing market is reviving again.