Nobody can escape convergence…but you can try to delay it

Real GDP growth has picked up this year, and the trend in industrial sector confidence signals scope for a further meaningful acceleration ahead. While we do not want to underplay the positive effects of a strengthening recovery in the Eurozone and the US, we see some reasons for concern in the household sector and investment prospects. Household consumption will face headwinds, as there is no space left to cut borrowing costs further, but house prices are rising, while wages will be flat at best, and probably down, in our view. On the investment side, capacity constraints are building, but inventories are relatively high, while modest pricing power would argue for delaying investment plans a little longer. We are not bearish on France – but, in our view, some structural challenges will continue to play in the background, limiting the upside, despite a highly favourable global growth backdrop. #ChangingFrance
Today, we publish our update on France, and there are two developments that we would like to flag here (many more charts are available in the full report).

First, the positive trend in industrial sector confidence, which is a good leading indicator for France, as it is for the rest of Europe (bar Germany currently), argues for a repeat of the strong GDP performance seen this year (Banque de France real GDP forecast: 1.7% in 2018, 1.8% in 2019, Bloomberg consensus: 1.8% in 2018, 1.7% in 2019, ADA: 1.4% in 2018, 1.5% in 2019). However, we see potential downside risks for household consumption and for investment.

On the household sector front: consumption has benefited from steadily falling interest rates and a recovering housing market, as well as a drop in the unemployment rate. However, with QE coming to an end and mortgage rates already very low, we suspect that consumption will no longer benefit from falling interest rates, while it may also suffer from the emerging signals of a growing appetite for savings. Also, in our view, French wages are likely to be compressed going forward – reflecting the powerful trend of convergence, which pushes up those with modest average wages, but pushes down those with wages above the European average (such as France). The increase in the minimum wage will soften this process, but cannot stop it, in our view. Hiring appetite is high: this is true, and will bring the unemployment rate down gradually. However, this does not necessarily mean higher wages: we could see a repricing of labour, as has been taking place in Italy and Greece. The different “health” of these two economies does not make the parallel inadequate: both have seen a loosening of labour laws and a compression of corporate profit growth, to which companies respond (among other things) with the laying off of old workers, while hiring new ones at lower wages, or simply slowly compressing the compensation of their existing staff.

On the investment front: capacity constraints are beginning to emerge, which are usually a good leading indicator for accelerating capex. However, much of the investment rebound is due to accumulating inventories – to the point that we doubt there will be more appetite in the near term – and, overall, in our view, the French business sector is suffering from lower profit growth (and the loss of pricing power relative to the historical performance), which may well delay a more robust investment cycle by a year, or even two.

The second thing we would like to flag is the emerging trend in the consumer surveys, which seems to suggest a desire to increase savings going forward. This could also be related to an expected, or genuine, but not visible, increase in inflation. In fact, the French households’ expected price trends are equivalent to those of German households (which should have experienced higher growth and, thus, higher inflation risk) and far above the trend for Italy.

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