Eurozone ECDI Update: Mind the gap

By Jeremy Hawkins, Senior European Economist
July 26, 2021

At any point in time, Econoday’s economic consensus divergence index (ECDI) provides a very handy snapshot of how an economy is performing relative to market expectations, a key factor helping to shape investor sentiment and hence, determine where asset prices might be headed.

In the Eurozone, economic activity is currently outperforming expectations – its ECDI is in positive surprise territory (latest value 11). In fact, the ECDI has been above zero for much of 2021 signalling that the region’s recovery from Covid this year has fairly consistently outpaced market forecasts. This is one reason why speculators are contemplating a reduction in the ECB’s asset purchases (QE) made under the pandemic emergency purchase programme (PEPP) next quarter.

However, the recent unexpected strength of the Eurozone as a whole has not been mirrored in its largest member states. The chart above shows unusually large performance gaps between the Eurozone on the one hand and France, Germany and Italy (together accounting for around two-thirds of Eurozone GDP) on the other. All three countries have been posting negative national ECDIs for most of July.

Apart from suggesting some inconsistencies in the forecasting process – essentially the combined ECDI profile of the Big-3 Eurozone states should broadly match that of the overall Eurozone – the gap also raises a warning flag over extrapolating too much from any individual country. Many Eurozone economic reports are released significantly later than their U.S. and UK counterparts so German (in particular) and French data are often used as proxies for the region as a whole. However, clearly of late these countries have not been good indicators of how the Eurozone has been performing versus market expectations.

Another point worth making is the impact of inflation on the ECDIs. The measure combines a range of economic indicators to provide an umbrella view of how economic activity is shaping up versus the market consensus. Normally, rising inflation is a sign of economic strength but, at least in part, the current upswing is a reflection of one-off factors such as Covid and higher oil costs. As a result, the boost to some national ECDI readings provided by the sharp acceleration in consumer prices so far in 2021 has helped to mask unexpected weakness in local real economies. So, for example, inflation in Germany was surprisingly strong in April and May but industrial production easily undershot the market consensus in both months. In other words, the real side of the economy was underperforming by even more than indicated by the German ECDI. Many business surveys that offer a composite summary gauge of economic activity (e.g. the PMIs) are currently similarly biased up.

In sum then, recent ECDI developments underline just how carefully economic data have to be interpreted in what is a very unusual global economic recovery where not all is as it seems. The ECDI synthesizes a lot of information into a convenient and extremely useful gauge of relative economic performance. However, it always pays to remember that the devil is in the detail.