Hamish McRae: Europe's cautious consumers could put a damper on growth and interest rates

Click to follow

The Eurozone economic recovery looks much more secure than it did even a month ago – but it is a recovery driven largely by exports, particularly to the United States. This raises fundamental concerns about the low level of domestic demand and poses the intriguing question: why won't eurozone consumers spend more?

The Eurozone economic recovery looks much more secure than it did even a month ago – but it is a recovery driven largely by exports, particularly to the United States. This raises fundamental concerns about the low level of domestic demand and poses the intriguing question: why won't eurozone consumers spend more?

This matters hugely in the future for it is obviously not secure for Europe to rely on external demand. Germany has long done so and has suffered slow growth as a result – one would not want this pattern to spread to the whole of the Continent.

The pattern of low – or at least lowish – personal consumption in Europe has been well established and in part is a function of high public consumption. This private consumption in Britain at 66 per cent of GDP compares with 57 per cent in German and only 54 per cent in France. But this propensity to spend less would not itself explain the most recent weakness. The eurozone retail confidence indicator, plotted with actual consumption in the 12 countries of the eurozone, is extremely weak and has shown no sign of recovery at all. If that relationship remains true the implication is that consumption will fall to zero in the next few months.

All the usual qualifications apply, for these relationships may fit beautifully on a graph but do not necessarily indicate a direct causal relationship. But you can get some corroboration by looking at the other graph, showing consumers' willingness to make major purchases. This too has fallen sharply since the beginning of this year and does not, as yet, show signs of turning up.

So what is happening? GFC Economics, the consultants who spotted the relationship, points out that this fall in willingness to spend may be partly the result of the introduction of the euro, now 100 days old. The spending of "mattress money" – the notes of the old currencies that had been sitting around and whose owners did not want to convert into euros – may have brought forward major purchases. This chimes in with weak car sales in the eurozone, in marked contrast to the UK where they have been extraordinarily strong. But GFC notes that a similar trend is evident in the US. Americans, it seems, have kept up their spending in general but are chary of making big commitments. GFC wonders whether either the weak stock markets or the rising energy prices are upsetting confidence.

My own take on this would be to look at perceptions of job security and expectations for interest rates. In Europe the normal assumption would be that job security is higher than in the US. For those in regular employment this is certainly so. But many Europeans are now on short-term contracts and for them the normal job protection legislation does not apply. In addition, because of their weaker job markets, people who do lose their jobs are less likely to be able to find another one.

As for interest rates, two things have been happening. Last autumn there was a sharp rise in long-term interest rates. This does not have any immediate impact on household finances but it has affected the housing market in Europe. Here, most home loans are still financed by floating interest rates, but on the Continent the general pattern is for loans to be fixed-term. These are directly affected by long-term rates, and while it is hard to generalise about such a diverse region, this rise in rates seems to have hit activity in the housing market. This in turn affects willingness to buy consumer durables, for when you move house you tend to re-equip.

The second thing that has been happening is fear of short-term rising rates. The cycle has clearly turned and while there are good reasons to suspect that the European Central Bank will tighten policy more slowly than the US Federal Reserve Board, the bottom of the global interest cycle is clearly past. The only way to go is up.

People know this. The puzzle is perhaps that here in Britain we don't seem to care, whereas in Europe people do. Our housing market races on, and while pace of growth in retail sales is off a little, there is no obvious sign of an end to the consumer boom.

My guess would be that the key difference in attitude between the UK and eurozone consumers is explained by combination of the stronger job market and the knowledge that a majority of the population has significant equity in its home. Add the specific uncertainty associated with the introduction of a new currency and a more general concern about ageing, pension provision and declining working populations. Result: a recipe for caution.

If this is right and consumer caution will rule in Europe for the foreseeable future, the consequences are threefold.

First, in the short term Europe will remain a low-interest rate zone. The ECB will neither dare nor need to push up rates fast. Some countries, like the Netherlands and Ireland, will continue to experience quite serious inflation for rates will be too low for them. But there is nothing than can be done about this.

Second, the European economy will continue to experience relatively slow growth, relative that is to the US and to a lesser extent the UK. Some parts of the Eurozone will be fine: Spain and Portugal will continue to close the income gap with the core. But until European consumers become more confident the eurozone cannot expect reliable brisk growth.

Third, there will be political consequences. If the eurozone countries wish to stimulate consumer demand and if consumers feel ratty that they are not richer, taxes will have to fall. Eurozone tax levels have been nudged down in the last three to four years but clearly not by enough to generate much additional demand. While older Europeans may well be happy with this balance between private consumption and public spending, the younger ones who would like to spend more and have to pay the taxes may well not be so content.

Come to think of it, if UK taxes go up next week, this young/old tension may become more evident here too. But that is another story.

Comments