The first data released following the UK decision to leave the European Union (the referendum was on June 23rd) signaled that the impact on Eurozone economy could be limited. Indeed, the major Eurozone confidence indices for July were only slightly below previous month's value and continued to indicate a moderate growth rate over the next few months.
The PMI indices were the first to provide encouraging signs. The Eurozone PMI manufacturing index fell from 52.8 to 51.9 while the PMI services index and the PMI Composite index remained almost unchanged at 52.7 and 52.9 respectively. The indices were at value in line with a moderate growth rate of Eurozone GDP in the coming months. German and French indices came out stronger than the Eurozone data, signaling that the countries most impacted by the uncertainties caused by Brexit can be the peripherals: Italy could be penalized by the banking crisis and Spain by the non-election of a stable government.
The most positive surprise was the increase of the European Commission Economic Sentiment Index from 104.4 to 104.6, in line with a 0.6% growth of Eurozone GDP in Q3 '16.
The rebound of financial markets after the initial shock is another sign of confidence toward the Eurozone. The DJ Eurostoxx recovered all the loss post-Brexit while the Dax advanced during the last week well above pre-Brexit levels.
After an initial negative reaction, the government bond markets also recovered. For example, the ten-year Italian BTP yield rose at 1.5% in the aftermath of Brexit but declined in the following week and on Friday 29th posted the record low of 1.16%.
The decline of the M1 growth rate from 9.1% to 8.6% is in our view the most negative indication for the outlook of the Eurozone economy. With Real M1 growth rate leading industrial production by 6 months, we see the decline of the last few months as a sign that industrial production growth rate could weaken at the tail end of the year. In this scenario, we think that current consensus estimate of a 1.6% GDP growth in 2017 could be revised down in the next few months.
More encouraging signals came from M3, up 5%, and from loans to non-financial sector, up 1.7%. The M3 increase is a positive sign for inflation. It offset fears of new deflationary pressures following the recent decline of oil price.
In this scenario, we think that the ECB should maintain an easing bias for many months. The ECB could announce in September, or at least further prepare investors, an extension of the asset purchase program from March '17 to September '17.
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