Our view is that the euro area can achieve a turning point in the growth cycle if 1) credit growth falls to around -1.0%, and 2) the pace
of deleveraging then stabilizes.
Credit growth fell to -0.5% in June, suggesting that while the adjustment process in the euro area is well underway it has not been
completed yet. The fall in credit growth has caused the credit impulse to remain sharply negative, and we expect domestic demand growth in the euro area in Q2 to be weak.
If demand contracts as expected, fiscal revenues will disappoint. The market remains vulnerable to further upward revisions in budget
The ECB’s bank lending survey suggests that credit growth should fall further in Q3 to around -1.0%. This implies a further negative credit impulse in Q3, but slightly less negative than in Q1 and Q2.
However, the expectations component of the survey suggests that credit growth could stabilize in Q4, which would imply a rebound in
the credit impulse towards zero. In our view this raises the likelihood that demand growth could stabilise in Q4, and that the end of Q3/start of Q4 could mark the turning point in the euro area growth cycle.
We are not at the turning point yet, and the turning point is far from inevitable. As economic numbers may disappoint in the interim, we maintain our tactically neutral stance on equities for the moment. However, the gradual nature of the decline in credit growth raises the probability that the pace of deleveraging can stabilize in Q4. The likelihood of a turning point is rising, and the timing is getting closer.
When the turning point is reached, we would expect spending and GDP growth to surprise positively, sovereign CDS to rally and equities to rerate. We would look to go overweight equities when we believe that the turning point is upon us.
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