The low-growth perception of Europe's consumer demand continues -- and that may be prompting a number of major corporations to look for greener pastures.
The recent announcement by Heinz (HNZ) that it will divest European businesses with sales of $1.4 billion followed similar moves by Unilever (UN) to reduce its product lines and by Cadbury Schweppes (CSG) to divest its European beverage business.
OIL FACTOR. Companies' skittishness may result from some lackluster economic trends. Real disposable-income growth in the Eurozone has averaged little more than 1% per year over the past three years. This compares with a growth rate of about 3% in the U.S. over the same period. Consequently, consumer demand in Europe's single-currency zone grew by a mere 1.5% per year on average from 2000 to 2005.
Looking ahead, consumer demand is going to remain highly dependent on developments in labor markets and on trends in oil prices. But a look at key countries within the Eurozone reveals some differences in the outlooks for consumer spending:
Consumption trends here in the past five years might tempt observers to assume consumers had adopted their Hong Kong counterparts' shop-till-you-drop attitude. Until the beginning of 2004, that is.
The most recent data revisions published by Britain's Office of National Statistics show that consumption growth picked up at the beginning of 2004, then slowed to a standstill in the first quarter of 2005. Since then, monthly data have consistently pointed to weak demand. The most recent retail sales index (August, 2005) showed that retail sales volumes were flat month-on-month and up only 0.8% over the past 12 months.
Several factors explain this turnaround. First, between November, 2003, and August, 2004, the official interest rate rose 1.25 percentage points, leading to an estimated 60-basis-point rise in the effective interest rate facing households. In the context of the booming real estate market prevailing at the time, this increase translated into interest payments going up by 4 billion pounds from the fourth quarter of 2003 to the first quarter of 2005.
IN THE RED. Second, British consumers, unlike most of their Continental counterparts, have been able to tap into the increased market value of their real estate through mortgage-equity withdrawals (MEW), an equivalent (although with more restrictions) of U.S. home-equity loans.
MEWs rose to a staggering 10% of total consumption at the beginning of 2004, representing a fivefold increase from the beginning of 2000. Since then, withdrawals have steadily declined, thus contributing to the overall slowdown in consumer demand.
A very sharp increase in indebtedness generally characterized the British consumer financial situation at the beginning of 2005. Expressed as a percentage of disposable income, household debt shot up to 140% in 2004, from 100% in 1999.
FEWER HIRES. We expect the recovery in British consumer demand to materialize only slowly, not least of all because the labor market is only gradually starting to reflect the broader downturn in the economy. The jobless rate remains within a slim margin of its lowest level in a generation. Nevertheless, unemployment is slowly creeping upward. In August, it climbed for the seventh month running.
The service sector has continued to hire, although job creation remains more heavily concentrated in the part-time end of the market. The pace of job creation has slowed, however, while layoffs continue in the hard-pressed manufacturing sector.
With margins under pressure across the board as a result of high energy prices, we expect even less hiring in the months ahead. The same survey showed that core earnings (that is, excluding the effect of bonuses) rose at their slowest rate since February, 2004.
WAITING TILL SPRING. At the same time, the effect of the Bank of England's 25-basis-point reduction in July of the official interest rate will be modest and slow to make itself felt. In fact, we expect the Bank to proceed with a fresh rate cut, to 4.25%, at the end of the year, before trending toward 4% in the course of 2006.
Meanwhile, higher oil prices are likely to prompt consumers to delay major spending decisions until after the winter of 2005-2006. The rise in heating oil prices has been particularly steep in Britain.
The country's consumption trends bring about contrasting observations. On the one hand, unlike their British counterparts, French households could not tap into the real estate boom to finance their consumption. On the other hand, consumer demand has shown a remarkable resilience since the beginning of 2004.
The rise in real estate markets could well have had a dampening effect on consumer demand in France, where homeowners cannot access additional borrowing from their existing mortgage on the basis of an increased market value of their property (there's no mechanism similar to the British MEW).
SAVING LESS. Overall, since 1998, prices for homes (excluding newly built homes) have increased by about 80%, while rents rose 112%. Over the same period, household gross disposable income rose only 20%. The sharp difference explains why homebuyers had to resort increasingly to bank loans.
When it comes to rents, however, credit facilities are irrelevant: Confronted with higher payments, households can either try to downshift and rent cheaper accommodation (as long as their lease allows them do so immediately) or cut spending on other items.
Despite these pressures, French consumers have proved willing to reduce their savings rate to maintain their level of spending, unlike their German counterparts. The most recent survey (August, 2005) shows French expenditures on manufactured goods up 5.7% over 12 months, while auto sales increased 9.5%. These are the highest year-on-year increases since late 2003.
SHORT-TERM GIGS. French consumers have received positive news recently: The national unemployment rate took a surprisingly large dip in July, as 30,000 people moved off the jobless rolls -- the largest single-month fall since January, 2001.
This development pulled the unemployment rate back to 9.9%, its lowest level in almost two years. Part of the improvement has resulted from accounting changes by the state unemployment agency.
Yet, one can expect this modest improvement in employment to continue for the rest of 2005, mainly as a result of various plans the government implemented in the past 12 months to facilitate hiring on short-term contracts. Total employment should increase about 110,000 in 2005, compared with 36,000 in 2004.
TAME INFLATION. The other positive news: The CPI has remained at less than 2% (1.8% year-on-year in July, 2005) as higher energy prices have been offset by the discounting and competition-inspired retreat in manufactured goods prices. For the rest of 2005, continued upward pressure from higher oil prices will most likely cause the rise in the overall index to approach 2% for the year, a level that still does not pose any major threat to household purchasing power.
Overall, we expect the increase in France's consumer demand to average 2% in 2005, thanks to a fresh drop in the savings rate, and to accelerate slightly in the next couple of years.
At first sight, it looks as though the bad times will never end for German consumers. The country has not enjoyed the housing boom seen in the Britain. At the same time, over the past six years, the corporate sector made heroic efforts to correct their deteriorating competitiveness resulting from the sharp rise in unit labor costs that took place at the beginning of the 1990s.
These efforts translated into a growing number of wage negotiations directly at the company level rather than in the context of industrywide arrangements. They resulted in a reversal in the secular trend toward fewer working hours and the introduction of "working time accounts" allowing companies to limit payments of overtime bonuses.
"ONE-EURO JOBS." Furthermore, these changes also heralded a much lower overall wage inflation rate. Wages essentially stagnated or declined in real terms in the past 18 months. Those readjustments have weighed negatively on household disposable incomes, leading to a stagnation in consumer demand since 2001.
More recently, data for the second quarter of 2005 have shown declining unemployment in seasonally adjusted terms, largely due to the unwinding effects related to labor market reform. The changes had initially added about 380,000 employable former social-welfare recipients to the unemployment statistics, of whom 50,000 dropped out of the labor force again in the second quarter on finding out that they were ineligible for benefits.
In addition, a rising number of unemployed has been soaked up by a growing supply of publicly funded "one-euro jobs," which offer a small income without providing prospects for a permanent position in the regular jobs market.
TAX RELIEF. Can consumers expect a light at the end of the tunnel? First, Germany's foreign trade results, pointing to hefty surpluses, have confirmed that the country's companies have essentially recovered their ground in terms of competitiveness. Although downward pressures on pay will remain strong, one can expect wage stabilization in real terms in the next 18 months. Second, consumer confidence has started to show modest signs of improvement.
Boosted by the tax cuts implemented in January, 2005, and possibly by the labor-market improvement in the first half of 2005 described above, consumers were reporting a higher propensity to buy (and lower tendency to save) through August of this year.
Unfortunately, there is every reason to fear that recent political uncertainty arising from the September parliamentary elections, combined with higher oil and gas prices, is going to throw more cold water on the nascent confidence recovery among German consumers. Those factors may lead many companies to postpone any hiring plans they might have had, while waiting for a clearer outlook.
As a result, we have reduced our 2006 forecast for German consumption growth to 1.5%, from 2% (0.4% is expected in 2005).
From Standard & Poor's Ratings Services