Euroland: A Swift Shift in Sentiment

• The ZEW economic expectations indicator increased sharply to 31.1 in May (consensus 20.0) from 13.0 in April. This brings the expectations index up to pre-crisis levels.
• The sharp increase in expectations strengthens our case that we will experience a strong rebound in Q3 with quite sharp increases in industrial production.
• The shift to a positive sentiment among financial experts is in itself very comforting, as the return of confidence in the economy is likely to be partly self-fulfilling.
• We adjust our expectations for PMI upward. We project Euroland manufacturing PMI to increase to 39.5 and service PMI to increase to 45.5 – well above market expectations.

Details

The ZEW economic expectations indicator increased sharply to 31.1 in May (consensus 20.0) from 13.0. This surprisingly sharp increase in expectations brings the expectations index up to pre-crisis levels. In fact it is the highest level since June 2006 and above the average level, which is around 26.

The sharp increase shows that there now are widespread expectations among financial analysts that the German and European economy will rebound within six months. 47% expect the economic situation in Germany to improve in six months, while only 16% expect the situation will get worse. The shift to positive sentiment has been rather swift. In December less than 10% expected an improvement in the economic situation while 55% expected a worsening. The current conditions index stayed very negative at -92.8 (consensus -90) down from -91.6. This is a record low. The current situations index is a lagging indicator – i.e. it tells us more about the past than the future. As such it is not very interesting, but it is nevertheless worth keeping in mind that the expectations of an improvement partly reflect how bad the current situation really is.

Assessment and expectations

The sharp increase in expectations strengthens our case that we will experience a strong rebound in Q3 with quite sharp increases in industrial production. Thereafter Euroland is projected to see more modest growth as many countries will struggle with large government deficits and continued declines in house prices.

The shift to positive sentiment among financial experts is in itself very comforting. The financial markets have been hit by a confidence crisis which now appears to be receding. The return of a positive sentiment and confidence that the economic situation is about to improve is likely to be partly self-fulfilling. The sharp improvement in sentiment may bring the credit tightening cycle closer to an end, boost share prices, and improve both the willingness and possibility for companies to undertake investment.

Due to today's positive surprise we adjust our expectations for PMI, which will be out on Thursday, upward and look for another positive surprise relative to market consensus. Last week we projected an increase in Euroland manufacturing PMI to 38.0 and the Reuters' consensus expects an increase to 38.4 from 36.7. We now project an increase to 39.5. We also project services PMI to increase more sharply to 45.5 from 43.8 (consensus 44.5, which was also our projection last week).

Today the ZEW expectations index surprised on the upside relative to consensus expectations as it normally does when ZEW is increasing. Similarly consensus tends to be surprised on the downside when ZEW declines. This even holds true for long periods of consecutive increases and decreases. We expect that ZEW can continue on its upward trend for several months to come. We should thus not be surprised to see that consensus is surprised on the upside again when we get ZEW expectations for June in a month's time.

Danske Bank http://www.danskebank.com/danskeresearch

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