Latest / The European Economy Podcast with Fexingo: ECB, Eurozone, and Continental Markets / Eurozone Growth Divergence Worsens as ECB Faces Hard Choices
Transcript
- Lucas: So the big story in European markets this week is really about divergence. And I don't mean the usual us europe rate divergence we talked about in Episode 2. I mean the growing gap within the Eurozone itself. Luna: The core versus periphery debate making a comeback? Lucas: Exactly. Look at the numbers from the last five trading days. The Vanguard FTSE Europe ETF, ticker V-G-K, is up about three-point-six percent. That's a solid week. But when you break it down by country, the picture gets a lot more interesting. Luna: Germany versus Spain, that kind of thing? Lucas: Precisely. Germany's ETF, e w g, is up four-point-two percent over five days. That's actually on the higher end. But that masks a structural problem: German industrial output has been flat to negative for several quarters now. The bounce is mostly driven by the weaker euro and some hope that the ECB will cut rates again in July. Luna: Right, because the trade-weighted dollar index hit 119.3 as of mid-May, and eur usd is down to 1.16. That helps German exporters in the short term. Luna: So the market is rewarding Germany for its export exposure even as its domestic economy stagnates, while Spain's services boom isn't getting the same love? Lucas: That's one way to put it. The Italian ETF, e w i, is up only two-point-four percent. Italy has its own issues — high debt, political uncertainty. The point is, the ECB faces a real challenge. One rate decision has to cover all these economies, and they're moving in different directions. Luna: And the Fed is about to get a new chair. Kevin Warsh is being sworn in this Friday. That could mean a hawkish tilt, which would strengthen the dollar further and put more pressure on the euro. Lucas: That's the external factor. Meanwhile, the Eurozone's nominal GDP is about thirty-one point nine trillion dollars, up from thirty-one point four trillion at the start of the year. But real GDP growth annualized is only two percent. So a lot of that nominal gain is inflation, not real expansion. Luna: So the ECB has to decide whether to cut rates to support lagging economies like Italy, or hold steady to avoid overheating in services-heavy ones like Spain. Lucas: Right. And there's a headline from earlier this week: Ed Yardeni, the economist, said the Fed will have to raise rates in July to appease 'bond vigilantes.' If that happens, the dollar gets even stronger, and the euro weakens further. That could help German exporters but raise import costs everywhere. Luna: It also complicates the ECB's job. A weaker euro might be welcome for growth, but it also feeds inflation through energy imports. And we saw that Putin and Xi are talking about reviving a stalled Russian gas pipeline. That could shake up energy markets again. Lucas: Exactly. The Eurozone is still heavily dependent on energy imports. If Russian gas flows become more uncertain again, that's a supply shock that hits manufacturing economies like Germany hardest. Luna: Let's talk about the UK, because it's not in the Eurozone but it's a big European market. The UK ETF, E-W-U, is up four percent over five days. And there was news about a uk gulf trade deal being called a 'monumental achievement.' That could be a boost for UK services. Lucas: It's a good reminder that Europe isn't just the Eurozone. The UK is charting its own path, and that trade deal could give it an edge in financial and professional services that the Eurozone doesn't have. Luna: So when you look at the ETF data — VGK at 88.88, EZU at 68.34, FEZ at 67.53 — the market is broadly positive. But the underlying divergence means the ECB has a tough call in July. Lucas: Yeah. And that's the angle I think is most important for listeners: don't just look at the Eurozone as a monolith. The performance of German stocks versus Italian bonds tells you very different stories. The ECB can only set one policy rate. Luna: So what do you think they'll do? Cut again? Lucas: I think they'll hold in June and then cut in July, but only if the data weakens further. The problem is that 'the data' is an average of very different national economies. The ECB's own staff projections will show a split screen. Luna: And on the other side of the Atlantic, we have a new Fed chair who's likely to be more hawkish. That divergence could widen further. Lucas: It could. But the flip side is that a weaker euro makes European assets cheaper for foreign buyers. We're already seeing that in the ETF flows. The question is whether that's enough to offset the structural headwinds in manufacturing. Luna: One more thing: the AI economy story that came out this week — it says blue-collar workers are poised to win. If that's true, it could boost services employment in Europe too, but it might take time. Lucas: That's a longer-term theme. For the next few months, the key variable is the ECB's reaction function. If they cut and the euro drops further, export-oriented economies get a boost. But if energy prices spike again, that benefit gets wiped out. Luna: So the takeaway for listeners: watch the German IFO survey and the Spanish services PMI. Those two numbers will tell you more about the Eurozone than the GDP average. Lucas: Exactly. And keep an eye on the eur usd exchange rate. At 1.16, it's already pricing in a lot of weakness. If it breaks below 1.15, that's a signal that the market expects more ECB easing. Luna: Alright, Lucas. Good to have this on the radar. We'll check back after the June ECB meeting. Lucas: Absolutely. Thanks, Luna.