The cooling of any residual eagerness to join the European single currency, evident at Number 11, is getting increasing support from the lacklustre performance of the eurozone economy. The "Britain has to bind itself to a bigger market" argument is being countered by a "Do we really want to link more closely to such a slow-growing zone?" one.
The last couple of weeks seem to have seen another downward lurch in the eurozone economy but there has so far been no response on rates from the European Central Bank. However some signs that inflation may be easing ought to give the ECB the opportunity to show it is listening to the mounting concerns – particularly from Germany – about the dangers of recession. The markets are split as to whether it will move at its next meeting, but they do expect a cut either at the end of August or in September.
Then the trouble begins. Once the mountain does move, the mood will change from teeth-sucking to nail-biting. At the moment the "it's all the fault of the ECB" lobby is making the running, with some justification, for the ECB probably has misread the balance of risks to the eurozone economy and held rates up for too long. But once it does start cutting – and so far it has made only a token quarter point cut – suppose nothing happens? What then?
The eurozone economy is a great puzzle. At the beginning of the year it seemed likely that this would be the first time for nearly a decade that Continental Europe would grow faster than the United States. There were a number of rational reasons for such a belief. For example: Europe was not as exposed to the high-tech sector; its consumers were not so over-borrowed; the euro was under-valued while the dollar was over-valued.
But somehow it hasn't turned out like that. Some parts of the eurozone are doing still fine, but those are generally the bits on the fringe: Ireland and Spain. Until a month or so ago France also seemed fine, though there are little doubts now. But Germany, which is the largest of the eurozone economies, accounting for one-third of total output, has disappointed. It may well have stopped growing in the second quarter and some forecasts for growth in 2001 are now below 1 per cent.
Worse, the forward-looking indicators are all pointing south. Some of these are shown in the graph. The top one shows the broadest forward-looking indicator of eurozone activity, the weighted average of national indicators calculated by the OECD and industrial production. If the indicator were right. You could argue that the eurozone faces as serious a recession in industry as it experienced in the early 1990s. That is not the same as a recession in the whole economy, for manufacturing is less than a quarter of the latter. Nevertheless, it is a bright red warning light.
The normal lag for the OECD indicator is about six months, so I suppose you could say that provided it turns up soon, a recovery early next year is still possible. But now have a look at the lower graph, which shows the main US and German lead indicators, drawn from surveys of business expectations. The US indicator has headed up for four of the past five months; the German one continues to fall – in fact it was the combination of the Ifo index dropping below 90 this week and bad news from several large companies that has spooked the markets. The lag – insofar as you can measure lags with any confidence – here is longer, perhaps a year. So as far as the US is concerned the signal is for a turning point by next spring; as far as Germany is concerned, there is no turn in sight.
It is hard to know why, except that the German economy has always been dependent on external demand: it needs strong exports to crank up. While it has the advantage of a weak currency, its exports sell more on quality than price and those exports tend to be of investment goods rather than consumer ones. So the fact that they are relatively cheap (and the US consumer is still spending) doesn't help much. The companies that might be buying aren't doing so, not because of price but because they don't want to buy the goods at all.
Now you can see the significance of the different US and European interest rate policies. The US cut rates hard from the beginning of this year. While the reaction has been unexpectedly weak, prompting concerns that monetary policy is less effective than it used to be, at least it has stabilised the fall on Wall Street and supported house prices in the States. Businesses are not buying but consumers are.
The ECB has hardly begun to cut rates, but when it does the great danger is that even less will happen in Europe than has happened in the States. European consumers are less sensitive to changes in rates because they are less heavily borrowed. Consumption in the eurozone accounts for a significantly smaller proportion of GDP – it is 67 per cent in the US but 57 per cent in Germany and only 54 per cent in France. (It is 65 per cent here. Interesting how much more we spend on ourselves than the French. Total consumption in the UK in 1999 was $950bn; in France only $787bn, and we have almost exactly the same population and GDP.)
The problem for the eurozone that is only just beginning to become evident is how to encourage consumers to spend more money. There are, to be sure, a few little positive signs: cars sales, particularly in France, have jumped in the last month. But because Continental Europe does not have the same floating rate mortgages or the amount of consumer credit that we (or the US) do, there is an even greater danger that interest rate cuts in Europe are pushing on a string. Give money to British people and we go and spend it; Continentals are more cautious.
No one should cheer that it is perfectly possible that the UK will grow faster this year than either the US or the eurozone – our relatively good performance will happen only because the other guys are doing worse than previously expected, not because we are doing any better. But you can see the misery that a "one size fits all" interest rate policy is creating in Europe.
You can see too the political significance of all this: why Messrs Brown and Balls want to play the euro entry game long. The five tests are becoming ever more useful. The longer it takes for the eurozone to recover, the longer the case for "wait 'n' see".Reuse content