Euro Zone GDP to Confirm Economy Shrank at Record Pace in First Quarter (Euro Open)

The second revision of Euro Zone Gross Domestic Product is expected to confirm that the currency bloc’s economy shrank -2.5% through the first quarter, the largest drop since the creation of the single currency. Australia surprised traders overnight as the economy unexpectedly expanded in the three months to March, boosting the Aussie dollar.

[U][B]Key Overnight Developments[/B][/U]

[B]• UK Consumer Confidence Expands For Second Month in May
• Australian Dollar Surges As Economy Unexpectedly Grows in Q1[/B]

[U][B]Critical Levels[/B][/U]

The [B]Euro[/B] was confined to a narrow range in overnight trading, oscillating in a 60-pip band above 1.4270. The [B]British Pound[/B] followed suit for most of the session but prices surged higher to breach the 1.66 level just ahead of the opening bell in Europe.

[U][B]Asia Session Highlights[/B][/U]

[B]UK Consumer Confidence[/B] expanded for a second consecutive month in May, according to Nationwide. The metric printed at 53 in May after a revised 51 result in April, the first print above the 50 “boom-bust” level since December 2008. The details of the survey revealed that 57% of respondents expect jobs to remain scarce and only 28% see the economy turning worse six months from now, the lowest percentages since October of last year. Stock market gains and moderating house-price losses likely accounted for the improvement in consumer sentiment: the benchmark FTSE 100 index has added over 30% since early March while house prices rose for the fourth consecutive month in May.

The [B]Australian Dollar[/B] surged against major currencies after the economy unexpectedly grew in the first quarter. [B]Gross Domestic Product[/B] expanded 0.4% in the three months to March; economists had expected the metric to shrink -0.2%. In annual terms, the GDP growth rate fell to 0.4% from a revised 0.8% in the final quarter of 2008. The result bolsters RBA Governor Glenn Stevens’ argument that Australia will weather the current global downturn better than other industrialized countries. Looking at the details of the report, consumption grew 0.5% and the external balance improved 1.4%. Private and government investment both declined. Aggressive stimulus measures are likely behind the impressive outcome: the central bank has brought interest down to the lowest in 49 years while the government has started to distribute more than A$12 billion in cash handouts to boost spending.

While the result is certainly encouraging, the important question going forward will be if Australia is able to sustain positive momentum once government stimulus dries up. Earlier today, the Treasury’s macroeconomics director David Gruen said he expects a “delayed” economic recovery in testimony to the a Senate committee but added the economy will grow at an annual pace of 4% in 2013-2017. Yesterday, the central bank kept interest rates unchanged at 3% for the second consecutive month but warned that additional easing may be needed given the prospect of medium-term deflation. Following the report, Australian Prime Minister Kevin Rudd and Treasurer Wayne Swan offered their rendition of the “good cop, bad cop” routine: Swan boasted that Australia outperformed other advanced economies and called the GDP figures a “very strong outcome”; meanwhile, Rudd said that the economy was “not out of the woods yet” and cautioned that there is “no guarantee” that the economy will not contract in coming quarters. A reserved outlook appeared to win out, with Swan conceding that Australia has yet to feel the full impact of the global recession.

[U][B]Euro Session: What to Expect[/B][/U]

The second revision of [B]Euro Zone Gross Domestic Product[/B] is expected to confirm that the currency bloc’s economy shrank -2.5% through the first quarter, the largest drop since the creation of the single currency. The outlook going forward is decidedly ominous: a survey of economists conducted by Bloomberg expects inflation-adjusted GDP to shrink by a whopping -4.2% this year, greatly overwhelming calls for a -2.8% drop in the United States. Looking further out to 2010, the onset of economic recovery is set to see GDP growth in the States outpacing that of the Euro region by 1.4%. On balance, this suggests the European Central Bank is likely to lag behind the US Federal Reserve in raising interest rates as the rebound materializes, hinting at a bearish long-term bias for EURUSD.

Indeed, the ECB has been notably more reserved than most of its major counterparts in offering monetary stimulus. Although ECB President Jean-Claude Trichet announced that the bank would move forward on quantitative easing with a scheme to “purchase euro-denominated covered bonds issued in the euro area,” details of the program (and thereby its actual commencement) have been delayed at least until the next policy meeting on June 4th. Such waffling may see the single currency punished in the weeks and months ahead as traders price in not only a longer path to recovery but also the political implications of inaction. Indeed, grumbling electorates are increasingly likely to entertain calls to free national monetary capabilities from the ECB’s “measured approach” as recession deepens and unemployment levels rise, threatening the very existence of the currency union itself.

Separately, [B]Euro Zone Producer Prices[/B] are set to fall -4.5% in the year to April, the most in over 28 years. Easing wholesale inflation will compound downward pressure on consumer prices from slowing economic growth as lower production costs are passed on via cheaper finished goods, threatening the region with the onset of deflation. Such a scenario stands to commit the Euro area to long-term stagnation as consumers and businesses perpetually hold off on spending and investment, waiting for the best possible bargain.

In the UK, May’s [B]Services PMI[/B] is expected to print at 49.5, rising from 48.7 in the previous month. The reading suggests the sector shrank for the 13th consecutive month, albeit at a slower pace.

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