The eurozone's trajectory - slow but steady?

News | 1 June 2016

Turtle

Hann-Ju Ho says that the eurozone will continue to be driven predominantly by domestic demand as low inflation and immigration expenses bite

The eurozone appeared to be enjoying a purple patch in the first quarter of 2016, but is everything as it seems on the surface? GDP growth was stronger than expected in the period, rising by 0.5% on the previous quarter and outperforming both the US and the UK.

As a result, the real level of output has finally surpassed the peak we saw in early 2008, before the global financial crisis hit.

But that has primarily been driven by strong domestic demand, with household consumption continuing to be supported by the income growth generated by low inflation, low energy prices and gradual improvements to the labour market.

This has been able to offset the weakness in the export sector, which reflects the softening of global growth prospects.

Last month the IMF revised down its global growth predictions from 3.4% this year and 3.6% next year, to 3.2% this year and 3.5% in 2017, describing the pace of growth as "increasingly disappointing".

But if you drill down into the eurozone data, monthly indicators suggest that momentum did ease during the quarter, and business surveys have also signalled a more moderate pace of expansion. As such, we expect growth to ease back in Q2.

Home and away

Domestic consumption is expected to remain the key driver of growth this year, while economic policy will also be sympathetic, given the expenditure that European countries have committed to tackling the refugee crisis.

Greece and other countries that have struggled to cope with the huge influx of refugees from war torn Syria and other countries are receiving hundreds of millions of euros in emergency EU funding, to help them cope.

Though investment trends, supported by low interest rates, are forecast to improve during the period, economic and political uncertainty will still be pushing back investment decisions.

But the unexpected raft of measures announced by the European Central Bank (ECB) in March 2016, when it expanded quantitative easing, cut interest rates and announced incentives for banks to lend, should support credit growth in the economy, despite ongoing pressures on parts of the banking sector to grow their balance sheets.

After the stimulus surprise in March, the ECB left policy unchanged in April, as expected, and we don't expect any further policy easing, at least in the near term.

Instead, the ECB's focus is now firmly on implementing the stimulus measures designed to incentivise lending that it announced in March.

Inflation apprehension

The ECB president, Mario Draghi, has urged patience in waiting for the impact of policy measures on inflation, but he will no doubt be concerned about the decline in underlying inflation this year, after previous hopeful signs of revival.

Consumer Price Inflation (CPI) fell back into negative territory in April at -0.2%, as the gradual pickup in core inflation that happened in spring and summer last year petered out.

This raises concerns about the speed with which headline inflation will reach the goal of being close to, but below, 2%.

We expect annual headline inflation to remain around zero in Q2, before moving gradually higher in the second half of the year, supported by a recovery in energy prices.

Overall, we expect CPI to average 0.3% for the year as a whole, before rising to 1.4% in 2017.

Too soon for more stimulus

Further policy easing by the ECB therefore remains on the cards, but June is likely to be too soon.

Without the expected recovery in inflation in the second half of the year, more stimulus measures may yet be announced, possibly in September.

With subdued global growth prospects and the depressed oil price also likely to continue to take their toll, we would stick to our annual growth forecast of 1.6% for the eurozone in 2016.

Within the eurozone, Spanish growth is expected to outperform the average, but will slow to 2.8 % this year from 3.2 % in 2015, while growth rates in Germany (1.7% France 1.5%) and Italy (1%) are forecast to be slightly stronger than last year.

It seems that, while global growth remains sluggish, domestic demand is likely to remain the driving force in the eurozone for now.

Hann-Ju Ho is a G-10 economist at Lloyds Bank Commercial Banking

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