MOODY'S EUROPEAN CREDIT TRENDS - DAILY MARKET WRAP
London, 01 August 2002 -- - Eurozone Manufacturing is Stagnating Not Collapsing
- Baa-Spreads Widen as Number of Fallen Angels Increases
- UK Manufacturing Contracts for First Time in Six Months
EUROZONE MANUFACTURING IS STAGNATING NOT COLLAPSING
"While the performance of the Eurozone's manufacturing sector remains
far from inspirational, the latest PMI points to a stagnation of
activity rather than a collapse. Despite the euro's recent appreciation,
global demand continued to fuel manufacturing growth. Moreover,
it is important not to overstate the extent of the recent re-alignment
of exchange rates, with the trade-weighted value of the euro
still some 10% lower than its ten-year average and fragile."
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While the performance of the Eurozone's manufacturing sector remains far
from inspirational, the latest PMI points to a stagnation of activity
rather than a collapse. Overall activity in the sector expanded
for the fourth consecutive month during July, albeit at a slightly
slower pace than in June. Both the output and orders sub-indices
were unchanged from the previous month. With economic growth idling,
inflation subsiding and equity investors crying, today's decision
by the European Central Bank (ECB) to leave interest rates on hold yielded
few surprises.
Despite the euro's recent appreciation, global demand continued
to fuel growth in the Eurozone's manufacturing sector during July.
While annualised GDP growth in the US economy slipped from 2002 Q1's two-year
high of 5.0% to just 1.1% during 2002 Q2,
the data continues to point to a pause and not a downturn in the current
recovery. Even though consumer confidence and the new orders of
durable goods (-3.8% for June) both experienced precipitous
drops, the housing market remains strong. Moreover,
the increase in business spending during 2002 Q2, while small,
was the first such increase since 2000 Q4. Perhaps more importantly
for the Eurozone's manufacturing sector, however, US real
imports increased at an annualised rate of 23.5% during
2002 Q2 - the fastest annualised increase since 1984 Q1 and notwithstanding
an exchange rate less conducive to import demand.
The outlook for the Eurozone's exports clearly depends on the development
of the global economy. While a stronger euro will raise the costs
of Eurozone exports persuading some foreign consumers to substitute exports
with cheaper domestically produced goods, a sustained recovery in
global demand will mitigate the impact on the overall volume of trade.
It is important not to overstate the extent of the recent re-alignment
of exchange rates, with the trade-weighted value of the euro
still some 10% lower than its ten-year average. Moreover,
the 3.7% depreciation in the spot exchange rate from its
peak reached in mid-July indicates that the fledgling euro currency
still remains vulnerable to swings in investor sentiment.
Unlike in the US and UK, Eurozone consumers have not continued to
spend throughout the current cyclical downturn. While unemployment
has risen in the US, a flexible labour market provides households
with some faith that companies will start hiring again as economic conditions
improve. By contrast, although the overall level of unemployment
in the Eurozone is still lower than during the mid-1990s,
tight labour market regulations in some parts of the Eurozone continue
to deter businesses from creating new jobs. The deflationary influence
of a stronger exchange rate will eventually increase the purchasing power
of Eurozone households - the impact of which should not be discounted
given that around half of all Eurozone trade remains intra-regional.
However, the dependence of Eurozone businesses on global demand
to stimulate revenue growth will persist until further reforms promote
a more liberal pace of job creation.
BAA-SPREADS WIDEN AS NUMBER OF FALLEN ANGELS INCREASES
Much has been made of the recent turmoil in global equity markets and
the concurrent widening in corporate sector spreads. Indeed within
Europe's corporate debt market, the average spread on euro-denominated
investment-grade bonds with a five- to 11- year maturity
widened by 12 basis points in July to their widest monthly average since
December. However, while the average spread on Baa-rated
bonds increased by 28 basis points during the month, the spread
on Aa-rated bonds increased by a mere two basis points over the
same period. Moreover, across the entire investment-grade
spectrum, only the average yield on Baa-rated bonds rose
during July.
Clearly investors have become more discerning. Telecoms and media
companies have fallen from grace over the past two years. And while
corporate Europe has not yet succumbed to the same level of accounting
scandals as its counterpart across the Atlantic, fresh hints of
scandals would undoubtedly threaten a further downturn in financial markets
globally.
The recent widening in spreads at the lowest end of Europe's investment-grade
spectrum may, however, also reflect an increase in the perceived
rating migration risk of the existing pool of issuers - a trend
that could have been exacerbated by an increase in fallen angel downgrades.
During July, a further three Baa-rated issuers were downgraded
from investment- to speculative-grade status, bringing
the total number of so-called fallen angel downgrades in western
Europe to six for 2002 to date. Over the decade ended 2001,
on average, just three fallen angel downgrades were recorded per
year in the region. However, it should also be noted that
over the same period, the number of corporate issuers in Europe
has increased fivefold. The six fallen angel downgrades recorded
in 1992 accounted for 8.5% of the total number of investment-grade
downgrades recorded in the region during the year. For the year
to date, fallen angel downgrades comprise around 7% of all
investment-grade downgrades announced in western Europe.
By Kerryn Fowlie
UK MANUFACTURING CONTRACTS FOR FIRST TIME IN SIX MONTHS
"House prices rose by 2.5% in the UK in June, contributing
to an annual increase of 21.0% - the fastest annual
growth in 13 years. The striking performance of the housing market
was in stark contrast to the contraction revealed in manufacturing activity
in July. The PMI index for UK manufacturing activity signalled
that the manufacturing economy contracted in July for the first time in
six months, with weakness in Eurozone demand adversely affecting
the export performance of UK manufacturers."
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House prices rose by 2.5% in the UK in June, contributing
to an annual increase of 21.0% - the fastest annual
growth in 13 years. Although down from a monthly growth rate of
3.3% in June, the change in July was still slightly
above the average for the last six months. The rapid pace of house
price growth does not seem to be letting up, buoyed by current high
employment levels, a belief that lending rates will stay at their
extremely low levels for a while to come and substitution away from equities.
House prices and equity prices diverged in value in July, with the
2.5% increase in house prices softening somewhat the impact
of the 10% fall in the value of equities. Some investors
are turning to 'bricks and mortar' as an alternative to poorly performing
equities, but the housing market is unlikely to remain immune to
the detrimental effects of the equity price capitulation on consumer confidence.
The striking performance of the housing market is in stark contrast to
the contraction revealed in manufacturing activity in July. The
PMI index for UK manufacturing activity slipped from 50.6 in June,
to a reading of 48.9 in July, according to the latest survey
by the Chartered Institute of Purchasing and Supply. This result
signalled that the UK manufacturing economy contracted in July,
for the first time in six months.
Foreign order books were reported to have contracted in July, driven
down by weak demand from the Eurozone. Trade with the Eurozone
accounts for more than 50% of all UK exports. And persistently
sluggish levels of domestic spending in the region have countered any
potentially positive impact from the recent appreciation in the euro.
For the three months ended May, UK exports increased by 7%
relative to the previous three-month period. However,
while exports to non-EU countries increased by 8.2%
over the period, those to the Eurozone rose at a more modest pace
of 5.8%. This point notwithstanding, firms
operating in the US dollar market have already signalled the adverse effect
of the stronger pound, which is likely to start showing up in UK
export data over the months ahead.
Firms continued to cut employment as they sought to minimise costs by
trimming excess capacity and stretch efficiency levels to increase productivity.
Scepticism about sustainable recovery increased amongst panel firms,
and the decision not to rush into expanding capacity seemed to be vindicated
in July as firms reported a further month of employment cutbacks,
in line with reduced overall demand for their products.
Margins were squeezed further as the growth in input price inflation accelerated
to reach a one-and-a-half year high in July.
The output price index contracted again in July, although the rate
of contraction slowed somewhat, as firms struggled to attract new
business.
As, expected, the Bank of England today decided to leave borrowing
rates at their 38-year low of 4% today, amid signs
of a faltering recovery.
By Alice Keegan
London
Kerryn Fowlie
Economist
Moody's Investor Services
Moody's Investors Service Ltd.
44 20 7772 5454
London
Alice Keegan
Statistical Economist
Moody's Investor Services
Moody's Investors Service Ltd.
44 20 7772 5454