Euroland: ZEW Jumps in line with our 'Outlier' Forecast

• The ZEW economic expectations indicator increased sharply to 44.8 in June (consensus 35.0, Danske Bank 45.0) from 31.1 in April. This brings the expectations index back to the highest level since May 2006.
• The sharp increase in expectations strengthens our case that there will be a strong rebound in Q3 09 with quite sharp increases in industrial production.
• We expect to see continued increases in ZEW, Ifo and PMI in the coming months although the pace of increases in ZEW expectations is likely to taper off.

Details

The ZEW economic expectations indicator increased sharply to 44.8 in June (consensus 35.0) from 31.1 in April. Forecasts from 40 analysts ranged from 25 to 45. We were the outlier on the upside. It is quite normal for the ZEW expectations index to improve quite sharply as survey participants start almost simultaneously to believe that the macroeconomic situation will improve in six months. The sharp increase in expectations brings the expectations index up to the highest level since May 2006 and well above the average level, which is around 26.

There is now a widespread expectation among survey participants (financial analysts) that the German and European economy will improve within six months. 54.1% expect the economic situation in Germany to improve in six months, while only 9.3% expect the situation to worsen. The shift to a positive sentiment has been rather swift. Back 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 -89.7 (consensus -93.0, Danske Bank -91.0) up from -92.8. The current conditions index is a lagging indicator, i.e. it tells 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.

Additional ZEW indicators send a more mixed signal. Survey participants' expectations of higher inflation are increasing and so are expectations for higher short-term interest rates, but not for long-term interest rates. Expectations of increasing oil prices have declined and so have expectations for stock market increases, although they are still at a high level.

Assessment and expectations

The sharp increase in expectations strengthens our case that there will be a strong rebound in Q3 09 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 a 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 to 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.

We expect to see continued increases in ZEW, Ifo and PMI in the coming months although the pace of increase in ZEW is likely to taper off. The increase in ZEW expectations hints that Euroland manufacturing PMI should continue to increase sharply.

ZEW expectations have increased broadly in line with the increase in the spread between the German two-year government yield and the ECB refi rate - if anything two-year rates have increased a bit too fast. The 10-year government yield has increased slightly less than the improvement in ZEW would indicate. We expect higher rates for both two-year and 10-year government bonds in 6-12 months (see New yield forecasts - Look for more yield increases).

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

Disclaimer

This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst 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 no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets´ research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S, which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange. Copyright (©) Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.