"Expect a relatively shallow upswing for the industry"
IHS Markit economic expert Ken Wattret: "The most important influence on the prospects of the manufacturing industry is the development of world trade".
Ken Wattret, Chief European Economist of IHS Markit in London, gave the following interview* to the BME:
BME: Germany's industrial sector ended 2019 with a weak performance and remains a thorn in the side of the economy. Do you expect a short-term end to this downturn?
Wattret: Germany’s industrial sector is likely to continue to struggle for a series of reasons, including the type of goods the country specialises in producing, notably automobiles and investment goods. The auto industry is going through a radical change, hitting consumer demand for traditional vehicles, while the high level of uncertainty over the economic outlook currently is dampening demand for big-ticket items more generally, from both consumers and businesses. Investment growth rates globally have been comparatively subdued in the post-crisis period and this looks likely to continue given the numerous uncertainties surrounding the outlook.
German industry has many advantages, not least the sustained competitiveness improvements against other eurozone countries since the mid-2000s. But in the absence of a clear improvement in economic prospects globally, the industrial sector will find it tough going.
Is a turning point already in sight?
Some leading indicators have turned more positive recently, including IHS Markit’s PMI figures. The forward-looking aspects of the PMI data, such as new orders and output expectations, started to turn upwards during the autumn of 2019 and with a lag of a few months, this normally passes through to actual orders and production.
However, some perspective is needed. The survey data including the PMIs are merely signalling so far that the rate of contraction in the industrial sector is diminishing. They do not point to an expansion as yet. We think this is coming over the course of 2020 but it is yet to be confirmed by the leading indicators and the pick-up, when it comes, will probably be relatively shallow.
In your opinion, what does Germany's manufacturing sector lack to stabilize in the long term and return to the growth path?
Domestic conditions in Germany remain positive, reflected in the very low unemployment rate for example. But the key influence on manufacturing prospects is the outlook for global trade. The leading indicators there are gradually turning more positive, including the global PMI’s new orders index, though it too is not yet signalling a return to positive growth, merely a lesser contraction.
A pick-up in demand for investment goods is a key missing link. The easing of monetary policy globally over the past year will have a positive effect on the economic climate over time, normally with a lag of around a year or so. But while the outlook is clouded by so many uncertainties, we should expect any pick-up in investment growth to be modest.
A more dynamic Chinese economy would be a big plus for Germany too but given China’s own economic headwinds, this looks unlikely to come to the rescue. Still, the better trade relations become between the US and China (and also the US and Europe), the lower the uncertainty will be, raising the probability of a sustained shift back towards positive growth during 2020-21.
The political situation in the US, however, suggests trade tensions are likely to be a source of uncertainty for some time yet.
Industrial production in the eurozone accelerated its downward trend once again in December. How high do you estimate the risks of recession it poses for the economies concerned?Germany itself has been flirting with recession for several quarters now, given the high share of manufacturing in GDP, and has missed it by a whisker. One major difference between the current situation in the eurozone and prior GDP recessions is that monetary policy remains very accommodative and will stay that way for some time.
That said, there are two risks to monitor closely which could tip industry-sensitive European economies into recession, and both are consumer-related. One is higher spillovers from weaker output into employment. The other is a sustained, supply-driven rise in oil prices. Both would hit consumer spending which has been the bright spot of the expansion.
The international business community has been following the brexit drama with great attention for several years. What do you think the UK's exit from the EU will mean for the UK and the European Union's economic cycle this year?
The acute event risk associated with “no deal” has diminished following the revised withdrawal agreement reached between the EU and the UK government, and the subsequent UK election result. However, the chronic problem of uncertainty over the ultimate destination of the relationship between the UK and the EU has not gone away. The risk has merely shifted back to the scheduled end of the transition period in December 2020.
For export-driven economies like Germany which are heavily linked to the UK, this is a continuing problem. Germany accounts for the highest single country share of UK imports and weak UK demand for big-ticket consumer and capital goods since 2016’s referendum has been a contributor to the slump in German industry.
Could an unregulated brexit, if the negotiations between Brussels and London fail, in the worst case scenario, also cause a massive downturn in the world economy?
Should a trade deal prove out of reach in 2020 and the UK exits the EU to trade on WTO terms from January 2021 onwards, this would be a very disruptive scenario for the European economy and would likely unleash another period of volatility on the financial markets.
One source of good news currently is the vigour of the US economy and the willingness of the central bank there to ease policy to try and mitigate the downside risks. This has also been supportive for emerging markets, which German is also linked to via trade. But there are limits to how far this can go and with the US expansion already unusually long, a major shock from Europe could have significant adverse effects across global economies and financial markets.
A “massive” downturn is probably an exaggeration. It would require more than just a UK exit on WTO terms to trigger a massive global recession, though it could be very damaging to sentiment.
How high do you rate the hopes of British companies to emerge stronger from the brexit?For UK manufacturers, the outlook looks very challenging. The UK government appears to favour a strategy of regulatory divergence, which is likely to reduce UK exporters’ access to EU markets. Increased barriers to trade with the UK’s key trading area will cause major disruption, particularly with today’s highly integrated supply chains. For service providers, the outlook also looks challenging, as passporting rights come to an end.
German economists repeatedly point to the political disruptive fires that cause uncertainty in the international markets, drive up prices and inhibit investments. In your opinion, how great is the influence of existing hotspots such as the trade dispute between the USA and China, the powder keg in the Middle East or the rising flood of refugees on the global economy?
German exporters require a lifting of the clouds of uncertainty over the global economy if demand for their goods is to recover. Tariff-related tensions and worries about the impact of Middle East conflicts on oil supplies are two key restraints on spending decisions currently and there are plenty of other risks which could materialise too.
Still, in our base case, some of these uncertainties will begin to lift and during 2020-21, a gradual recovery is likely to emerge in our view.
*The interview was conducted by Frank Rösch, BME-Economic and Commodity Monitoring