Position: Long Germany via EWG
We’ve had our EYE on Eurozone inflation and forecast to see mild inflationary numbers into year-end and next. Today Eurostat released Eurozone CPI at -0.3% in September year-over-year, with monthly inflation at 0.0%. While still deflationary on an annual basis, and down from -0.2% in August, we expect a slight uptick in inflation over the intermediate term, buffered by a strong Euro.
As always, divergences in inflationary/deflationary numbers reflect structural issues on an individual country basis within the framework of the Eurozone, and will remain a political football for the ECB when it considers raising interest rates. As of yet, there’s been little rhetoric on the WHEN, however Trichet has recently signaled displeasure with a strong Euro (now bordering on the $1.50 mark) as it erodes the competitiveness of Eurozone exports.
September inflation data shows a clear divergence among countries: Ireland and Portugal are experiencing the most deflation, at -3.0% and -1.8%, respectfully. The two largest economies in the region, Germany and France, stood at -0.5% and -0.4%, near the region’s average, while Malta and Finland topped the inflation charts at +0.8% and +1.1%. As before, we continue to believe that structural issues that weighed on certain countries into the downturn will encourage and prolong deflation, and therefore recovery, as we move out on duration.
The major components driving annual CPI deflationary were Energy (no big surprise) and Transport costs, down -11% and -3.7%, while Food and Housing saw declines of 1.3% and 1.6% respectively. Due to tax and duties, Alcohol and Tobacco saw strong inflationary pressures at +4.4% annually.
Alongside inflation we’re beginning to see upward revisions for GDP growth across the Eurozone. Importantly, Germany was revised up to 1.2% in 2010 (from a recent IMF prediction of +0.3%), with Chancellor Merkel stating that even average growth of about 1% would only show that Germany is “slowly emerging from the trough.” Yet, she also stressed in a recent speech that Germany’s industrial base shall help the economy outpace many of its peers, a point we agree with. Further, the Bank of Italy said the country emerged from recession in Q3, expanding 1% Q/Q. Cited for stepping up manufacturing, Italy’s push from a Q2 GDP of -0.5% is bullish for an economy that is heavily dependent on trade with the Europe.
As economies melt up, we expect inflation to follow at a relatively stable rate across the region. We continue to like Germany, including its low inflation environment as it encourages consumer consumption.