Steady as she goes….
The latest EY Eurozone forecast confirms that the region is stable and that very little has changed in the last 3 months. Viewed in the context of the crisis that the Eurozone found itself at the epicentre of last year, this is good news. The feeling of crisis has definitely passed and some of the economic data has moved into positive territory.
…but steady is not enough…
After such a crisis, it is natural for policy makers to view the achievement of a stable outlook as a major success, but after a crisis of the scale we have witnessed in the Eurozone, slightly positive forward momentum is insufficient to drive a significant increase in business activity. This assessment is reinforced when we dig into the forecasts and see projected growth in GDP for Germany, France and Italy below 2% annually through to 2018: these are historically low rates of growth in Europe’s major economies. Moreover, forecasts for the southern economies indicate little progress in resolving may of the fundamental challenges around public and private debt levels in those countries.
After the Summer, it seemed as though the relative improvement in the Eurozone’s position in the world economy, albeit driven by to the slowdown in emerging markets rather than faster recovery in Europe, was a positive development. However, we are now seeing increased optimism in the global economy and the Eurozone growth projections once again appear relatively weaker.
Policy makers in the Eurozone are edging closer to implementing some of the reforms that have been in development for some time. But progress is slow and unconvincing, certainly there has been little to convince business that the commitment to reform is serious and unwavering.
..to persuade business to invest
There are undoubtedly some positive developments in the Eurozone such as the growth in exports from the periphery, reflecting productivity improvements in these countries leading to a strengthening of manufacturing. Inward investment held up surprisingly well in 2012 and the outlook in selected key sectors such as construction is more positive. In the main though this activity is being driven by the potential for exploiting the increased relative competitiveness of the Eurozone to export to other regions.
By contrast, the prospects for domestic demand growth overall are limited and certainly not of a scale to stimulate a major increase in investment. The EY forecast has fixed investment growing at something like 2.5% per annum in the coming years which is significantly lower than the levels of growth that we would expect after the scale of slowdown the Eurozone has experienced. This is little evidence of the significant bounce back that is required to create positive momentum in the minds of businesses after several difficult years.
Much needs to be done. With squeezed consumer markets and high levels of unemployment, especially amongst young people, limiting future growth in consumer sectors, contraction in lending with SMEs being disproportionately affected, ongoing concerns about the banking sector and the spectre of deflation now a real issue, identifying value creating investment is very challenging.
For business, the downside risks are significant and outweigh the upside. There remains a risk of further shocks and the potential returns on offer are not of sufficient scale to incentivise risk taking.
Policy makers must do more…
The conclusion is clear: stability is not sufficient to create the basis for recovery on the scale and in the timeframes that the Eurozone requires. Urgent action is required. It is too early to conclude that the Eurozone is slipping into deflation but nevertheless some of the policy initiatives being pursued in Japan look very relevant for the Eurozone.
As a minimum the Eurozone requires:
- More expansive monetary policy designed to incentivise lending and ideally to weaken the Euro;
- Corresponding fiscal support in the form of a revised approach to the austerity programmes to reduce the demand being taken out of the economy; and
- An acceleration of structural reform to implement the changes already identified covering both the actions to increase the confidence in the monitoring and financial robustness of the economy and those designed to liberalise markets and create opportunities for business growth.
…if they want businesses to commit
At this time, aggressive expansionary strategies make no sense to corporates and would be unlikely to generate adequate rewards. In the USA and UK we can see momentum growing and businesses are fast reaching a point at which they will have to make decisions on whether or not to commit resources. The Eurozone is not at this point. However, with greater stability, now is the time for businesses to begin to develop their view of the medium to long-term position in the Eurozone and to consider what this implies for their strategy and business model. But for now, absent more support from policy makers, it is steady as she goes at best.