The strong euro is taking its toll

With the euro having jumped above the mark of 1.60 $ for the first time in history, recent macroeconomic data shows that the strong currency is taking its toll on the continental European economy. The advance manufacturing PMI for the euro-area for April published today fell by 1.2 points to 50.8 points and thus is only marginally above the 50-points-mark the fall below which would signal a contraction of the manufacturing sector. This is the lowest level since August 2005.

The drop in the PMI shows clearly that the euro economy (and also the German economy) is not immune to a strong appreciation (see my post on the recent debate in Germany here). The drop in the PMI was mainly driven by a deterioration of the forward looking components. So, according to the survey, orders have already contracted in April. NTC research, which is running the survey, stated that this was due among other factors to the strong euro.

The deterioration seems to be broad-based across the euro area: The German manufacturing PMI dropped by a strong 1.5 points to 53.6 points. While the indicator is thus still pointing to robust production growth in the German manufacturing sector, the German economy is clearly also suffering from the strong euro.

What is worse is what we did not see in the advance PMI: Given the details we know from Germany and France and EMU as a whole, we can now safely interfer a quite strong drop in the PMI for Italy and/or Spain. In both countries, the PMI survey for March had already pointed to a contraction (with 46.4 points in Spain and 49.4 points in Italy). Given the now-reported strong drop in the Euro area PMI combined with a similarly large drop in Germany, but only a small drop in France leaves us with a very high probability of a significant fall in the South of the currency area.

As we have predicted on Eurozone Watch, this would point towards the fact that the strong euro will hurt the countries in EMU with an already weak competitive position (Italy and Spain) more than Germany or France.

Another indicator that divergences are set to grow worse is the German statistical office’s announcement this week that German hourly labour costs in 2007 have grown less than in any other EMU country. Even though Germany has been experiencing faster growth than Italy or France, it has again improved its competitiveness, making permanently divergencing growth rates over the coming years more likely.

Unfortunately, in Germany, no one really sees the pain the real depreciation in EMU inflicts on the trade partners. The Frankfurter Allgemeine Zeitung, Germany’s leading conservative daily, titled today’s editorial on German labour costs with the words “Cheaper is better” (“Billiger ist besser”) stating that the current trend is exactly the one Germany should continue. But if I think about it: The Frankfurter Allgemeine Zeitung was never especially keen on European integration to start with…

This post has been co-posted at Eurozone Watch.

5 Responses to "The strong euro is taking its toll"

  1. BJ   April 25, 2008 at 9:31 am

    I think you’re right, Sebastian. After a decade of adjustment Germany is the healthiest Eurozone member. It needs to take the lead with higher consumption in order to jump-start other EMU countries’ exports. Real wages finally need to rise.

  2. Anonymous   April 25, 2008 at 2:47 pm

    BJ: Germany will not take the consumption lead. Ask German car dealers.

  3. BJ   April 25, 2008 at 4:55 pm

    1) borrowing costs are high and rising and the ECB doesn’t think of compensating – it even wants to hike. 2) The exchange rate is overvalued and there isn’t even a hint of verbal intervention. 3) Global external shocks are driving food and energy prices higher but purchasing power is not allowed to be restored. It’s certainly not all the ECB’s fault but if it wanted to put obstacles in EMU’s way it could hardly do a better job.

  4. Guest   April 26, 2008 at 6:23 am

    http://www.sueddeutsche.de/wirtschaft/artikel/550/170055/VDMA President Wittenstein confirms here that current business was contracted at a rate of $1.20/EUR. Fulfilling these contracts means losing money these days. "A weak dollar (and YEN) is a clear advantage for our American and Japanese competitors."

  5. Play On   April 29, 2008 at 8:09 am

    What is the outlook for the 2008 travel season in Europe at 1.56 dollars to the Euro? Is it bad or really really bad?