European markets are reeling as economic data points to worsening conditions despite promises that European economies will receive monetary support. European shares ended last week on a rally after the European Central Bank hinted at more quantitative easing, but many economists warn that the bounce has little to do with fundamental strength in the economy.
According to one note by a large investment bank, the bounce is likely more a result of the “nicest house on a bad block” phenomenon, where options globally are less appealing, and a bet against the euro and on European equities may be the best way to earn a positive return. The ECB's comments helped Germany's DAX stock index to rise more than 1.6 percent last week after a steep decline following similar falls in China, the United States, and throughout emerging markets around the world.
Weak Demand across the Continent
European activity and global demand seem to be weakening, at least according to one indicator from Germany. The country’s manufacturing PMI stunned analysts with a sharp drop to 52.1 in January, below 53.2 in December and far below expectations. At the same time, the country's services PMI also fell to 55.4, a drop from 56.0 in December. Both readings fell short of expectations.
Additionally, one indicator of disinflation is now pointing towards actual deflation throughout the Eurozone. Private sector firm input costs fell in January for the first time in nearly a year.
Analysts believe that Germany's manufacturing index is one of the most important indicators of global demand, since Germany's companies often produce machines used in China for producing consumer-facing goods. Thus, the composite manufacturing PI fall may indicate weakened conditions in China that other indicators have also confirmed, and that have caused investors to sell off Chinese equities and lose confidence in broader Asian growth in 2016.
At the same time, retail sales in the United Kingdom fell at their highest rate in more than a year in December, which some analysts are saying because of cold weather. While volume of sales including fuel fell 1 percent, according to the Office for National Statistics, prices also saw a steep decline, falling 3.2 percent in December.
Consumers in the country seem especially hesitant to make purchases, as clothing, shoes, and textiles plunged 6.2 percent. Falling prices and falling sales volumes could be pointing to a deflationary trap, in which a vicious cycle of lower spending caused by expected falling prices leads to worsening economic conditions. Many economists have expected the ECB to intervene more aggressively, while recent data in the UK may also encourage the Bank of England to work to counteract falling pricing and lower economic activity.
ECB Loose Monetary Policy
Already ECB president Mario Draghi reiterated his bank's attempts to use monetary policy to encourage more spending, investment, and general economic activity in the Eurozone. Draghi said that the ECB would "review and possibly reconsider” its monetary policy position, hinting that more quantitative easing may come to the Eurozone later this year.
A continued weakening of the euro could cause problems for China, which has faced mounting pressure to devalue its currency because of the quantitative easing programs in Japan and Europe. Some analysts expect, and some investors have been actively encouraging, Chinese policymakers to make moves to devalue the yuan sometime later this year.