- The EA narrowly escaped recession in 2022 by growing by 0.1% in Q4
- Inventory data is ambiguous; but broad money growth is collapsing
- A recession is more likely than not – but it should be short and shallow
Euro Area GDP edged up ever so slightly (0.1%) in Q4. Today, we were told that EA retail sales – a coincident, not a leading indicator – rose in January, although by less than expected. Does this mean, as the ECB and consensus want to have it, that the EA escaped a recession after all? My former colleague, Simon Ward, addresses this question from a monetary perspective on his always very readable Money Moves Markets journal. He is rather pessimistic, noting that narrow money is contracting and broad money at best is flat.
I certainly agree with Simon’s monetary analysis, but here, I want to start by examining the EA’s prospects from a different perspective, namely by looking at inventory perceptions in manufacturing. Historically, of course, the inventory cycle was the business cycle and inventory perceptions remain a very powerful near-term leading indicator.
Every month, the EU commission asks manufacturers in each EU member about how their own stocks of finished goods compare to ‘normal’. The answers are then presented numerically, where 0 is normal, a positive shows a balance of manufacturers perceiving inventories as above normal; and a negative number showing the opposite.
The February survey shows a few key developments. On the one hand, in the EA as a whole, in France , the Netherlands and Belgium, among the larger economies, inventory perceptions peaked at the end of 2022 and have since edged slightly down. In Italy they are unchanged since about six months; while in Germany and Spain they are still somewhat elevated. But, on the other hand, for the EA, Germany and Spain, inventory perceptions are bang on their long-term (since 1985) average. For France, Italy, the Netherlands and Belgium, they are well above the long-term average.
This makes for a slightly complicated picture. The fact that inventory perceptions are edging down, combined with the fact that they are in some countries (and notably in the EA as a whole) on their long-term average, argues in favour of an optimistic analysis, that is to say that the EA may escape a formal recession. On the other hand, higher readings in some countries make for more pessimistic reading, that weak demand in coming months could still push the EA into two quarters of falling GDP after all.
Bringing in the monetary data, however, darkens picture. EA M3 grew by 3.5% in the year to January, the lowest rate since November 2014. On a three-month annualised basis, M3 contracted in both December and January and the level has barely budged since August last year.
Add, finally, continued high inflation, meaning that the ECB will continue to raise interest rates. That should further slow broad money growth and dampen activity (as it is, of course intended to), and the conclusion is that the EA is more likely than not to go through a recession in 2023. However, the good news is that this recession should be reasonably short and shallow. Business survey data is still relatively optimistic, consumer confidence while weak, is turning up and the labour market remain healthy. Of course, much will depend on the course of monetary policy, a field where the ECB recently has not shown itself particularly skilful.