Research Pent-up demand in investments could boost euro area growth
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1 Investment General Market Conditions 3 September 2013 Pent-up demand in investments could boost euro area growth The euro area has finally moved out of recession and at this stage pent-up demand could become a major contributor to a recovery. However, there is rather limited pent-up demand in private consumption. Hence, we do not expect a significantly higher growth rate due to unleashed consumption but the contribution to growth should be modest. On the other hand, the amount of pent-up demand in business investment is considerable. Enterprises have saved and held back investments for almost five years and the return of confidence should imply that postponed investments are initiated. We predict investments to have a positive contribution to growth of 0.3pp annually during However, previous years postponed investments give an upside risk to our forecast and could imply a boost to growth in Among the four biggest countries of the euro area the amount of pent-up demand in investments is most pronounced where the crisis hit hardest, but postponed investments in the core countries are expected to be initiated faster. Growth supported by domestic demand 3 % q/q AR % q/q AR Private consumption >> << Investment GDP >> Pent-up demand in investments could boost growth Significant pent-up demand in business investments The euro area has finally moved out of recession and we predict low but increasing growth throughout our forecast horizon, see The Big Picture: Global growth shifts to a higher gear, August The recovery will be supported by global growth, but domestic demand is also expected to have a positive impact as consumer and business confidence have started to return. Both private consumption and investments are likely to increase throughout our forecast horizon. For business investments we predict a pick-up from previous years drag on growth and there is an upside risk to our forecast due to almost five years of postponed investments. The increase in private consumption, on the other hand, should be more muted as the amount of pent-up demand is limited. There is significant pent-up demand in investment excluding dwelling. Enterprises have increased their savings and held back investment for almost five years since Lehman collapsed. Recent surveys indicate that around 40% of German SMEs have postponed investment and adopted a wait-and-see attitude mainly due to euro area uncertainty. This is likely to be the case for SMEs in other countries as well. The postponement of business investments is reflected in the non-residential investment ratio to GDP, which is 1.4pp below the centred long-term average. The improvement in business confidence together with a stronger outlook for euro area growth and consumption should imply that postponed investments are initiated and this should result in higher growth in investments. Since 2008 the average drag on euro area growth from fixed investments ex dwellings amounted to 0.6pp annually and in Q1 13 the negative impact on growth was 0.3pp q/q. Looking ahead, we predict total investments to have a positive contribution to growth of 0.3pp annually in But previous years postponed investments give an upside risk and could imply a boost to growth. Note: The long term averages are calculated as a centred moving average running over 15 years. Contribution to growth from investments turns positive Analyst Pernille Bomholdt Nielsen perni@danskebank.dk Important disclosures and certifications are contained from page 4 of this report.
2 Differences in business investments across countries Across the four biggest countries of the euro area the amount of pent-up demand in business investments is most pronounced in the countries where the crisis hit the hardest. In Spain and Italy, the ratio of investment ex dwellings to GDP is below the centred long-term average. In Spain the deviation is 2.5pp and in Italy it is correspondingly 1.8pp below the average. This suggests that as business confidence improves in the periphery countries and the growth outlook becomes better postponed investments will have a positive impact on growth. Since 2008 the annual average drags on growth from nonresidential investments in Spain and Italy amounted to 1.9% and 1.1%, respectively, and indicate that the return of business confidence is crucial for a return to growth. However, it might take some time for investments to be initiated and the release of pent-up demand is expected after our forecast horizon, which ends in In Germany and France, there is also pent-up demand and the deviation from the longterm average for business investments is 0.9pp and 0.6pp, respectively. Germany especially has made more progress in terms of a return of business confidence compared to Italy and Spain and the pent-up demand could be released faster. Even though German pent-up demand has not been unleashed yet, the return of confidence has resulted in a contribution to growth from business investments of 0.1pp q/q in Q2 from a drag of 0.3pp in Q1. Limited pent-up demand in private consumption The amount of pent-up demand in private consumption seems rather limited. The household saving rate increased slightly at the beginning of the crisis but has been on a downward trend since 2010 as private consumption increased faster than disposable income. As growth returns the saving rate is likely to increase again towards its long-term average, reflecting lower growth in private consumption than in disposable income. The downward trend, to some extent, reflects that those affected by unemployment have been forced to lower their saving rate radically due to reduced disposable income. In Italy and Spain, gross disposable income has declined or moved sideways since 2008, whereas it has increased in Germany and France. This is also reflected in the countries saving rates, which are below the long-term average in Spain and Italy, around the average in France and just above average in Germany. The differences across countries suggest some pent-up demand in the countries that were least affected by the crisis, but the amount should be rather limited. There might be a considerable amount of retained consumption for major new purchases like cars and durable goods as they are 21% and 18% below the average since 1990, respectively. The pent-up demand for cars will also be growth supportive through the production channel as Europe produces around 20% of global auto production. Most pent-up demand in business investments in Italy and Spain Note: The long term averages are calculated as a centred moving average running over 12 years. Little pent-up demand in consumption Source: Eurostat Differences across countries Source: Eurostat Investments above average during the boom period has been reversed Also limited pent-up demand in investments in dwellings Following the end of the housing market boom, housing starts fell dramatically. The ratio of investment in dwellings to gross national disposable income is now 0.9pp below the centred long-term average. The ratio has been below the average since Q2 09 and the aggregate undershooting amounts to 9.4pp. Ahead of that the housing market boomed and there was an aggregate overshooting of the long-term average for investments in dwellings of 9.1pp. This indicates that the oversupply during the boom has been reversed and that investments in dwellings should soon start to catch up. Note: Deviation from the long term average calculated as a centred moving average over 15 years. When the overall housing market turns, the impact on growth will be positive but a significant amount of pent-up demand is not expected to be released as the boom period s oversupply is only slowly reduced. Additionally, we expect the contribution to growth to be rather limited. From the average contribution to growth from investment in 2 3 September 2013
3 dwellings was 0.2pp annually. Likewise, since 2011 the average drag on growth from the decline in investment in dwellings is around 0.1pp annually. Cross-country differences in investments in dwellings For investments in dwellings there are also large cross-country differences and the impact on growth varies considerably. In Spain, where the domestic housing bubble hit hard, the average drag on growth from investments in dwelling since 2008 was 1.1pp annually. The period of aggregate overshooting during the housing boom in Spain has almost been reversed, but the trend has not turned and due to a continued fall in house prices we do not expect investments in dwellings to have a positive contribution to growth within our forecast horizon. The Italian and French economies were also affected negatively by investments in dwellings and the drag since 2008 amounted to around 0.2pp annually. In Italy the underinvestments have only been limited and in France there have barely been underinvestments. Hence, we expect a continued period of low investments in dwellings in both countries. In Germany the period from 2004 until 2011 was characterised by investments in dwelling below the average and recent overinvestments have not yet reversed the undershooting. This suggests a period with a positive contribution to growth from investments in dwellings and a continuation of the period since 2008, where the impact on growth amounted to 0.1pp annually. Limited underinvestments in Italy Note: Deviation from the average since Room for investments to contribute to growth in Germany Note: Deviation from the average since September 2013
4 Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S ( Danske Bank ). The author of the research report is Pernille Bomholdt Nielsen, Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in the research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts rules of ethics and the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of highquality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Management and the Compliance Department. Danske Bank s Departments are organised independently from and do not report to other business areas within Danske Bank. analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors upon request. Risk warning Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis of relevant assumptions, are stated throughout the text. Date of first publication See the front page of this research report for the date of first publication. General disclaimer This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for informational purposes only. It does not constitute or form part of, and shall under no circumstances be considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or options, warrants, rights or other interests with respect to any such financial instruments) ( Relevant Financial Instruments ). The research report has been prepared independently and solely on the basis of publicly available information that Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any loss of profits, arising from reliance on this research report. The opinions expressed herein are the opinions of the research analysts responsible for the research report and reflect their judgement as of the date hereof. These opinions are subject to change, and Danske Bank does not undertake to notify any recipient of this research report of any such change nor of any other changes related to the information provided in this research report. This research report is not intended for retail customers in the United Kingdom or the United States. 4 3 September 2013
5 This research report is protected by copyright and is intended solely for the designated addressee. It may not be reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank s prior written consent. Disclaimer related to distribution in the United States This research report is distributed in the United States by Danske Markets Inc., a U.S. registered broker-dealer and subsidiary of Danske Bank, pursuant to SEC Rule 15a-6 and related interpretations issued by the U.S. Securities and Exchange Commission. The research report is intended for distribution in the United States solely to U.S. institutional investors as defined in SEC Rule 15a-6. Danske Markets Inc. accepts responsibility for this research report in connection with distribution in the United States solely to U.S. institutional investors. Danske Bank is not subject to U.S. rules with regard to the preparation of research reports and the independence of research analysts. In addition, the research analysts of Danske Bank who have prepared this research report are not registered or qualified as research analysts with the NYSE or FINRA but satisfy the applicable requirements of a non-u.s. jurisdiction. Any U.S. investor recipient of this research report who wishes to purchase or sell any Relevant Financial Instrument may do so only by contacting Danske Markets Inc. directly and should be aware that investing in non- U.S. financial instruments may entail certain risks. Financial instruments of non-u.s. issuers may not be registered with the U.S. Securities and Exchange Commission and may not be subject to the reporting and auditing standards of the U.S. Securities and Exchange Commission. 5 3 September 2013
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