Bleak economic development in the Euro Area continues in the fall 2014

by Paavo Suni

The Research Institute of the Finnish Economy ETLA
on September 5, 2014

Euro Area growth remains weak at 0.2 and 0.1 per cent in the third and fourth quarters of 2014 according to the Eurogrowth Indicator calculated by the EUROFRAME group in October. The quarterly growth estimates are unchanged from September and translate into year-on-year growth rates of 0.8 and 0.6 percent, respectively.

The growth estimates were unchanged from September, although the model was re-estimated. However, the composition of the growth contributions changed somewhat due to the new estimation. The independent variables were the same as in the previous model, but the lead of the construction survey was extended by one quarter to five quarters, and two lags of the dependent variable were added.

While the re-estimation improved the statistical properties of the model, its message continues to be quite bleak. The quarterly contributions from the industrial survey improved slightly from September, but confirm a worsening of the previously robust industrial sentiment since the beginning of the year. The contribution of the construction sentiment with a long lead weakened a bit and continues to act as a drag on growth.

The impact of the household survey to the quarterly GDP estimates changed quite much in the October estimation. Historical contributions were in general much better and the estimates of the third and fourth quarters turned positive from their previously negative impacts.

The real USD/euro exchange rate has a neutral impact on the two quarterly GDP estimates. The recent devaluation of the euro vis-à-vis the USD due to a change in the relative interest rate outlooks in the US and in the Euro Area will affect the indicator with a lag in early 2015.

The weakening of the euro after the ECB’s related announcements on reductions in its key rates and on new unconventional monetary policy measures in September should support the weakening industrial confidence.

However,the uncertainty relating to the crisis in Ukraine seems to be very persistent and unpredictable. The crisis has obviously already weighed negatively in particular on the Euro Area industrial confidence and turned its contribution negative since the second quarter of 2014. Should the crisis flare up again, it would weaken the estimate of the fourth quarter GDP growth in the Euro Area further.

Indicator methodology

The Euro Growth indicator forecasts the euro area GDP quarterly growth rate two quarters ahead of official statistics using a bridge regression. Regressors are chosen among survey data and financial data, i.e. series which are rapidly available and not revised. The monthly series are converted to a quarterly basis by averaging their monthly values. Series selection is conducted on an econometric basis starting from the set of monthly business and consumer survey results released by the European Commission: industry, construction, retail trade, services and consumers. From this large dataset, a few series are significant stemming from industry (production trend and expectation), construction (confidence indicator) and households surveys (major purchases). Two financial series are also significant, i.e. the growth rates of the real euro/dollar exchange rate and of a Euro area stock market index.

Some of these regressors are leading by at least two quarters, and may be used as such to forecast GDP growth. Some others are not leading or are leading with a lead which does not suit a two-quarter-ahead forecast horizon. These series have to be forecast, but over a short time-horizon which never exceeds four months. All these forecasts are implemented using monthly autoregressive equations.

The Euro Growth indicator is run each month, soon after the release of business and consumer survey results.

For any further information, please contact Hervé Péléraux

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