Europe Continues To Grow

By Thomas Cooley, Charlie Nusbaum, and Peter Rupert

The good year for Europe continues, according to the second quarter numbers released by Eurostat this month. Indeed, annualized quarterly GDP growth for the Euro Area rose from 2.2% to 2.6% during 2017Q2, while that for the Union as a whole increased from 2.2% to 2.7%. At first glance, it may seem as though the EU lags the United States, which grew at an annual rate of 3.0% during the second quarter of 2017 (here). Compared to this time last year, however, the EU grew marginally faster (0.2 percentage points) than the US. gdp_quart_growth_map.png

The Czech Republic, which we have omitted here, far outpaced the rest of the EU with an annualized growth rate just over 10%. The Netherlands and Romania also saw significant growth of 6.2% and 6.5%, respectively. Several countries, however, continued to struggle this quarter. Italy, the UK, and France saw meek growth ranging from 1.2%-2.0%. Portugal and Finland also seem to have deflated compared to their first quarter performance with annualized growth decreasing by 2.6 and 3.3 percentage points, respectively.net_exports_growth_maps.png

The European Union improved its trade balance as well, with net exports for the EU28 growing at a 10% annualized rate during 2017Q2. Here, we have applied a top- and bottom-code of 100% and -50%, respectively. Clearly,  Portugal, Switzerland, and Norway, among others, more than doubled their net exports this quarter. Ireland, France, and Greece on the other hand, saw their net exports halved. Hungary, Spain, and Sweden also saw high net export growth, ranging from 32% to 55%; whereas Germany, Belgium, and Denmark shrank net exports by 21%-48%.

Because international trade can be quite volatile, it is often more instructive to compare the change in imports and exports over the past year, rather than constraining ourselves to a quarterly analysis. Compared to this time last year, the vast majority of EU countries are doing quite well. The Union as a whole saw net exports grow by 6.7% since 2016Q2 and the Euro Area increased the same by almost 10% this past year. The Eastern and Western economies were the primary drivers of this growth with countries such as Hungary, Malta, and Lithuania improving their trade balance by over 50%. Ireland, the UK, and France, experienced more modest yet impressive rates of 45%, 21%, and 20%, respectively. Finland, Poland, and Greece on the other hand decreased their net exports by roughly 50% each. Many of the central European countries also saw negative net export growth, suggesting that the decline in these countries this quarter is part of a long-term trend.netLY_exports_growth_maps

Household consumption maintained its annualized growth of 2% from 2017Q1 through the second quarter. Romania and Ireland, the two poles in this category, experienced a change in household spending on final goods and services of 11.3% and -4.5%, respectively. Save for Portuguese, Lithuanian, and Greek consumers, households from every other country in the EU increased their expenditures.HHCons_growth_map

Moreover, capital formation in the EU increased by 2.5% since 2016Q2. The only member countries decreasing their investment in capital are Malta, Greece, Ireland, and Bulgaria.FX_Cap_Form_Growth_map

Of these four countries, however, only Bulgaria and Greece remain below their pre-crisis levels in 2008.


Additionally, the labor market has continued improving through 2017Q2. The Union as a whole decreased its unemployment rate from 8% to 7.7%, a downward trend reflected by almost every member economy.unemp_change

Clearly, however, the Southern European economies are still lagging behind their Northern neighbors. Greece maintained its status as the weakest labor market with an unemployment rate remaining above 20%. The Spanish, Italian, and Croatian labor markets also remain particularly weak with over 10% of their labor force without work. The slow recovery of the French labor market also seems to have stalled. Not only does its unemployment rate remain more than double that of the United States, it also did not enjoy the same decline this quarter as its fellow EU members.unempadj_quart_map

The employment to population ratio continued to improve for most member nations. The 2017Q2 numbers for many countries of interest have not yet been updated by Eurostat. Instead, we report the 2017Q1 numbers for this measure, which were not available to us back in June.emp_quart_tsThe Beveridge curve for the Union seems to have almost completed its cycle this quarter. Since 2006Q1, however, the match efficiency between unemployed workers and vacancies seems to have decreased as indicated by the outward shift of the red portion of the curve relative to the green portion.EU_Beveridge_Curve

These second quarter numbers give us confidence that things are in fact heading in the right direction for Europe. While there remain several areas of concern detailed here and elsewhere, the promising first quarter of 2017 does not seem to be a fluke.

Are European Banks Holding Back Growth?

By Thomas Cooley, Charlie Nusbaum, and Peter Rupert

Roughly three months ago, Spain’s Banco Popular was bought and saved from complete failure by the Santander Group after it faced a bank run and a total collapse of its stock price. The cause of Banco Popular’s problems can be traced back to the 2008 financial crisis. As several others have recognized (here), Banco Popular maintained a portfolio of almost $40 billion in non-performing loans (i.e. loans over 90 days past due) in its home-market. Compared to its 2016 balance sheet totaling over $100 billion in loans, these failing assets constituted a significant fraction of its portfolio. In light of these events, it is useful to look at the health of the European Banking sector to see if it will be a serious impediment to our optimistic take on European growth and promising signs for the EU economy, detailed in our previous post, or worse, leading to a new financial crisis for Europe.

NPLsGiven that Banco Popular’s problems can be linked in part to its massive portfolio of non-performing loans, this is a natural place to start for the rest of the Union. Indeed, it is evident that the Greek and Cypriot banking sectors are a great risk to their respective economies. During the first quarter of 2017, non-performing loans composed 46% and 43% of all loans in Greece and Cyprus, respectively, numbers above those of even Banco Popular prior to its crash. To get a better picture of the rest of Europe, we removed these two countries from our map.


It is clear that Greece and Cyprus are not the only countries that are at risk. Portugal, Ireland, and several Eastern European countries hold a relatively high proportion of non-performing loans. Together, these countries display non-performing loan (NPL) ratios of roughly 10.5%-18.5%. While not nearly as worrisome as an NPL ratio of 40%, these banking sectors pose a potential risk, particularly when compared to the 1% NPL ratio seen in the United States. Moreover, Spain seems to be slowly correcting course, decreasing their NPL ratio from 6.3% to 5.5% over the past year. While they still have work to do, Spain appears to be on the right track.

A bank’s ability to absorb losses is also of great concern, here we consider the tier 1 capital ratio, measured as the ratio of retained earnings and shareholder’s equity to total risk-weighted assets. Furthermore, because Estonia’s 37% capital ratio washes out the rest of the graph, we have omitted it. Clearly, Portugal, Italy, and Spain need to do more. With tier 1 capital ratios of roughly 11.5%-12%, they fall well below the EU average of 14%. While they remain both compliant with the Basel III capital requirements for the EU and comparable to three of the six largest US banks, we believe that they should continue to improve this measure in light of shaky profitability indicators that we discuss below. Ireland and the other Southeastern countries, however, seem to have recognized their questionable positions with tier 1 capital ratios closer to 18%-19%.


Several European areas show signs of little to no profitability as well as measured by the return on equity (ROE). To better contrast the remainder of the EU, we have omitted Portugal and Cyprus as they display a ROE for 2017Q1 of -3.2% and -1.2%, respectively. Coupled with their high proportion of NPLs, these abysmal profitability numbers show that Portuguese and Cypriot banks may be in serious trouble. It is also evident that Greece’s 1.3% ROE needs to improve to compensate for their failing loans. While it may seem that Greece is improving due to its 9 percentage point increase in ROE since the end of 2016, there may be a strong cyclical component at work here. Indeed, Greece displayed an almost identical ROE for 2016Q1, but saw large negative returns for the rest of the year. Italy and Ireland, on the other hand, seem to be doing about average in this department, with returns of roughly 7% each. Interestingly, Germany also shows meek returns of only 3.9%. While this is up 1.7 percentage points from this time last year, it is surprising nonetheless. Only the Eastern and Northern EU countries outperformed the 9% average ROE for U.S. banks.


Digging a little deeper, we find that the Greek and Cypriot banking sectors may be in the early stages of a self-correction. With an operating cost-income ratio of only 49% and 54%, respectively, they fall well below both the EU average of 64% and the U.S average of 59%. Portuguese data again indicates trouble with a cost-income ratio of 70%, whereas Irish banks again seem to be in the middle of the pack. Germany is once again surprising in terms of operational efficiency with a cost-income ratio of almost 78%. Though this measure has decreased almost 50 percentage points since 2015, it highlights the need to keep a watchful eye on German banks should the previously detailed risk indicators take a turn. The same can be said for France.


While many 2017Q1 GDP aggregates suggest a good year for the EU, the banking sector warrants concern. Portuguese, Greek, and Cypriot banks show a need for immediate worry in almost every indicator of financial health. Moreover, Irish and Italian banks show potential signs of trouble on the horizon, though the danger does not seem imminent. Banks in the rest of the EU seem to be doing relatively well, though Germany and France could improve from an operational efficiency standpoint.

A Promising New Year For Europe

By Thomas Cooley, Charlie Nusbaum, and Peter Rupert

Eurostat recently released estimates of first quarter GDP for the Eurozone and other EU member nations showing GDP growth of approximately 0.6% (here). Indeed, GDP growth rates increased by 1.9% and 2.1%, respectively, relative to the same time last year. In light of these promising, albeit modest, gains for Europe, we reexamined the Three Europes detailed in a previous post. It now seems that Europe is on a new somewhat brighter path with many countries experiencing renewed growth. To be sure many countries remain below pre-crisis output levels but they have in fact begun to grow.


The economies of Germany, the Netherlands, and Denmark all remain strong, exceeding their pre-crisis output levels by 3.5%-8.5% with average quarterly GDP growth rates of 0.3%-0.8% since 2014. Moreover, Spain’s growth rate has far exceeded that of any of the northern economies for quite some time now and is on track to catch up with the North should trends continue. Portugal’s economy seems to have gained steam as well while France and Italy continue to see meek growth. The big exception is still Greece which has not yet been resuscitated and remains flatlined roughly 27% below its pre-crisis output. As with previous posts, we have omitted Ireland because it swamps the data and is a bit distorted by the way foreign intellectual capital affects the national accounts.



First quarter trends are perhaps most easily seen geographically. Here, we see that first quarter European growth has largely been driven by Spain, Portugal, and the Eastern EU countries. Surprisingly, growth in the United Kingdom lagged behind virtually all other member nations since the start of 2017.


Moreover, while we can be less certain regarding growth in the next few quarters, we expect these longer term trends to continue or even improve. Indeed, fixed capital formation, the key to economic growth, increased in most countries during 2017Q1 relative to 2016Q4. Capital formation in Greece and Italy seems largely unchanged from the end of 2016, indicating that their growth trends are likely to remain lackluster absent other major interventions going forward.


From a labor market perspective, the Tail of Three Europes continues into 2017. Here, we report the March unemployment numbers as Eurostat has yet to update this indicator for all countries of interest. We see that those countries in the North have the lowest unemployment rates and those in the South have the highest, while Central Europe is somewhere in between. Relative to the end of 2016, however, unemployment has decreased in all countries but Denmark, where the unemployment rate is roughly the same as the end of 2016.


Labor force participation does not seem to follow the same stark geographic trends as unemployment. Here again, 2017Q1 numbers are not yet available for many countries of interest. Instead, we present 2016Q4 numbers. Iceland is the clear winner, with over 90% of its working age population either working or looking for work. Coupled with its low unemployment rate, the labor market in Iceland seems to be the strongest in the Western World. While Iceland is the clear winner, and Turkey and Italy seem to be the losers, the virtual boundaries seen above are absent, rather a more gradual gradient appears here. In other words, the differences between those wanting to work in neighboring countries seems to be small.


Finally, since the end of 2016, the Euro has regained much of its lost ground relative to the dollar. The “collapse of the Euro” as described by some, has stopped. Perhaps a combination of improving performance and a renewed sense of stability resulting from the polls leading up to the French election– and its outcome– have restored confidence in the Union. While a lot can change over the next 6 months, 2017 is showing signs of a good year for Europe.


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