Industrial Production in the Eurozone

Recent data has shown that Industrial Production has increased in May, but numbers are insufficient to propel investor sentiment higher in the absence of an improved trade outlook. Hence, the possibility that manufacturing could be in for a weak second half of the year is still present. However, should employment remain stable, an outright Eurozone recession remains unlikely.

In December 2017, Industrial Production peaked but has been on the decline ever since. While the indicator is volatile and plenty of one-off factors have been impacting the industrial sector over the past year and a half, the trend is worrying.

Although the reasons behind the downturn remain a mystery, as some indicators are still pointing to decent performance, it does seem that weakening global demand and trade uncertainty have had a more significant impact than initially expected. More sluggishness could be on the horizon due to this.

Remarkably though, the contraction in activity has not caused employment to decline.

Export growth is still positive but is weak

Production seems sensitive to weakened global demand and trade uncertainty. Still, German exports compared to the U.S and China have held up pretty well and national accounts data suggests that Eurozone exports of goods are still rising.

That said, the growth rate has been slowing distinctly – except for a brief pick up in the first quarter mainly related to UK stockpiling. This adds to mixed views on the downturn in production as it begs the question as to whether external demand can really be the problem when exports are still going up.

Production has declined most amongst export dependent industries

Even though export growth is still positive, business surveys have been pointing to a contraction in orders from abroad.

Furthermore, there is a strong correlation between the percentage that industries produce for foreign final demand and the performance in production since December 2017. The industries that produce more for foreign final demand have shown to be doing much worse than the ones producing more for domestic final demand.

Weaker gross exports are possible

While export growth has remained positive up to now, weaker production of intermediates used for exports indicates that weaker gross exports could well be a possibility. Another supporter to this view is the reported deterioration of Eurozone companies’ international competitiveness.

While the outlook for industry is uncertain due to a few mixed signals, sluggish global demand and trade concerns are expected to drag on in the upcoming months. That means an instant bounce back in manufacturing production is unlikely in the second half of the year and concerns about Eurozone GDP growth remain significant at least for the remainder of 2019.

Risk of recession?

As has been said, since December 2017, there has been a decline in production. A decline this long without a contraction in GDP has not been seen since the 1960s and in the early 2000s during the dotcom crisis. During these, many Eurozone countries experienced a recession.

In the second half of last year, Eurozone growth saw a marked slowdown but has managed to avoid a recession.

How long can this industrial downtrend continue without broader consequences?

The strong performance of the service sector has kept the Eurozone economy from contracting. Remarkably enough, the poor performance of the manufacturing sector has not yet led to a decline in employment growth in the sector.

The expansion of the 2000s was marked by a strong decline in manufacturing employment, but the current picture is the reverse of that. Employment in the manufacturing sector continues to grow, thereby supporting household consumption, which in turn mainly benefits the service sector.

That being said, there are signs that manufacturing employment could turn down though. In fact, certain businesses have indicated that hiring intentions in the manufacturing sector are weakening and in Germany, layoffs have increased while short-term work is returning.

Although this is a possibility, an overall growth in manufacturing employment could result in a contained decline in industrial production. Therefore, the manufacturing job market could be key in the months ahead to see whether the expansion can hold out amongst industrial sluggishness.