German economy contracts

Financial markets have multiple factors to focus on this week including central bank decisions and earnings, however, economic data is also in focus. Germany’s economy contracted in Q2, falling 0.1% last quarter, worse than the 0.1% growth expected. This means that since the start of 2022, Germany’s economy has registered a negative growth rate for 5 quarters. Germany is once again the sick man of Europe. Inevitably there is a comparison between the UK and Germany, while we won’t know the UK’s Q2 GDP data until 15th August, the UK’s Q1 GDP figure was 0.7%, a rate of growth Germany has not surpassed since Q1 2022.

These figures are preliminary GDP figures, so we do not get much detail however, they are adjusted for inflation, which fell in Q2. The bad news for Germany is that Q3 growth seems to have also got off on a weak note. IFO business confidence fell sharply in July, and the July PMI reports showed the composite PMI report falling to 48.7 vs. 50.6 expected. There were declines in Germany’s service and manufacturing sector PMIs, however, the decline in the manufacturing sector was shocking. It fell to 42.6 this month, which is deep in contraction territory, due to a decline in new orders, particularly international orders. This was the weakest rate of growth since April and suggests that the bounce back in Germany’s economy earlier this year was temporary.

So, why is the UK’s economic prospects so much brighter than Germany’s right now?  The IMF has said that the UK economy is approaching a soft landing, after recovering from recession faster than expected in Q1. This is something that the German economy has not been able to do, with volatile growth rates since 2021. The rapid drop in inflation in the UK has also boosted growth, which has not happened elsewhere to the same degree. Inflation rates in German regions that were also released today showed inflation picking up this month. The annual rate of headline inflation rose to 3.1% in Saxony on a YoY basis. Thus, although service price inflation remains an issue in the UK, on a headline basis, the UK is ahead of its European counterparts.

It also appears that the June rate cut from the ECB has not shifted the dial for the German economy. In contrast, the UK’s economic prospects could be buoyed further if the BOE takes the plunge and cuts rates on Thursday. We are not yet convinced that they will do so, however, there is currently a 56% probability of a rate cut priced in by the overnight swaps market, which has been rising in recent days.

Thus, from a fundamental perspective, the future outlook is also brighter for the UK, especially since economic growth is at the heart of the new UK government’s agenda. The tax burden in the UK, which has risen to a multi decade high in recent years, is also lower than Germany’s. Since no European economy is talking about tax cuts, this is also in the UK’s favour.

In contrast to Germany, French and Spanish growth rates are more in line with the UK, suggesting that Germany is an outlier. The French economy expanded at a 0.3% rate in Q3 but is rising at an impressive 1.1% annual rate. The Spanish economy expanded at a 0.8% rate in Q2. The euro is higher today, even with Germany’s economy contracting last quarter. The euro has been subdued for most of the summer, however, it seems to be making gains ahead of key central bank meetings this week.

The FTSE 100 is also in focus today as it bucks the trend of a higher open for European shares. Instead, it is down roughly 0.5%. The decline is led by Astra Zeneca and Diageo. Results season is also impacting markets. BP is one of the top performers on the market after it reported a 10% jump in its dividend, and it beat net income forecasts. FX is also in focus. The euro is German growth also fell back into negative territory FX is also in focus. So far this week, the yen and the pound are the weakest performers in the G10 FX space, however, that could also change after the BOE and BOJ meetings later this week. US futures are set to open higher today ahead of some key earnings releases including Starbucks and Microsoft after the US market closes later tonight.

Some FTSE 100 performers are worth watching closely on Tuesday. Astra Zeneca is down more than 1.7% on Tuesday after the NHS said that it could not recommend Astra’s Emhart breast cancer drug for use on the NHS. This comes after Astra Zeneca’s CEO said that the UK’s access to drugs could shrink if the NHS does not start to pay up. The Labour government has announced a 20% pay rise for junior doctors to stop strikes, which should be good news or UK growth, which has been impacted by however, surely the doctors need access to these life saving drugs to do their work?

Elsewhere, Reckitt Benckiser is leading the FTSE 100 on Tuesday after reaching its lowest level in a decade on Monday, due to its links to the Abbot baby formula. The focus this week is on earnings and central bank meetings. The S&P 500 is expected to open higher later today ahead of the key Fed, BOJ and BOE meetings later this week.