Of all the eurozone economies, Germany is suffering most from its inability to control interest rate...
Of all the eurozone economies, Germany is suffering most from its inability to control interest rates, with its manufacturing sector declining a further 0.5% in September.
Nonetheless, the country will have to leave its manufacturing sector to the mercy of movements in the euro as control over its fiscal and monetary procedures now rests with the European Central Bank (ECB).
The manufacturing sector, which accounts for 80% of industrial production, fell by 0.1% year on year to September 2002. However, unless interest rates are cut, the sector is at the mercy of movements in the currency, says Aaron Barnfather, Pan European fund manager at Newton. Germany has already been reprimanded for its budget deficit and is not stimulating growth through fiscal measures.
Barnfather says: 'Germany has no room to manoeuvre as it has used all its fiscal powers and cannot exercise its monetary powers. Under EU regulation, the stability pact limits Germany's borrowing so it will probably have to raise taxes rather than reduce them to meet the requirements of the pact.'
Barnfather adds the US dollar has been weakening, which has thrust the euro into a strong position and created a big problem for manufacturing.
If ECB interest rates stay where they are and the dollar keeps weakening, the euro will gain in strength, making exports even more expensive.
Richard Reid, researcher at SchroderSalomonSmithBarney, says despite Germany being one of the region's strongest members, the ECB will be unable to bail out any individual country, putting Germany in danger of a policy failure. However, he also believes while Germany remains a major concern, the eurozone as a whole is probably experiencing nothing more sinister than an old-fashioned pause in growth.
Germany's inflexible labour laws are also having a negative impact on its manufacturing sector. Barnfather says the labour laws in Germany are difficult to restructure because of staff protection legislation. The government has a stake in some of the German companies and prevents these from restructuring.
The biggest manufacturing industries in Europe are cars, engineering and machinery, oil and chemicals and paper and pulp. Barnfather says European manufacturing has been hit by competition from the Far East, which has a cheaper cost base.
He adds: 'Countries like Germany and Scandinavia have a high cost base. On the other hand, costs are cheaper in Spain and Eastern European countries.
'Spain has a lower cost of production as, when it joined the EU, it went in with lower costs because its currency had been devalued many times compared with Germany's deutschmark. Moreover, when joining the EU, countries such as Spain and Ireland benefited from lower interest rates, which boosted demand and lowered costs.
'If there are deflation risks, they are probably highest in Germany. Underlying domestic growth is at its weakest for more than 50 years, reflecting an overvalued exchange rate, structural weaknesses and overly restrictive monetary and fiscal policies.'
However, Reid adds, the ECB is set to cut interest rates by 25 basis points in December, which may alleviate some of Germany's manufacturing sector problems.
The ECB is likely to cut rates in December.
Some EU countries have a low cost base.
Most other EU countries not critically hit.
Entry deadline: Friday 28 September 2018
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