Eurozone Forecast: A return to growth doesn’t mean the crisis is over

Back in positive territory…

Eurozone GDP will grow by around 1% this year according to EY’s Spring Euro zone Forecast. After several tough years, this is welcome news with an upturn in consumer spending, investment and exports. It is also the case that bond yields in the periphery have fallen sharply and financial investors have begun to look again at the Eurozone in search of potential bargains.  In part this change in financial market sentiment reflects a slowing of growth in many other markets: the Eurozone is performing better in relative terms as other countries falter.

…but the crisis is not over…

The detailed estimates in the EY forecast illustrate the scale of the challenge still facing the Eurozone:

  • GDP will grow at around 1.5% between 2015 and 2018, too slow to make a significant impact on unemployment which wills till be at over 11% in 2018;
  • Exports will grow at 3% in 2014 and then at around 4% for the next 4 years, again insufficient for the Eurozone to catch up the income since 2010;
  • Consumer spending will grow at around 1.2% per annum between 2014 and 2018, very slow given the fall in spending in the last couple of years;
  • Investment will grow at around 2.5%, a very slow rate given the fall in investment since the financial crisis, suggesting there will be a lack of momentum behind the recovery; and
  • By 2018, Government debt to GDP will be almost 98% across the Eurozone.

…and risks remain …

So growth is returning but it is very weak and certainly lower than we would normally expect following a recession of the severity the Eurozone has experienced and significant risks exist. In particular:

  • Deflation is now a potential concern with inflation at 0.8% currently and real concerns that the lack of growth in the money supply and credit , the output gap and labour market conditions could drive prices lower;
  • Divergence continues to increase across the currency union, Germany’s economy is performing strongly and indicators point to continued growth, some of the peripheral countries are making progress but core states such as France, Belgium and the Netherlands are slipping behind Germany;
  • The high levels of unemployment both place a significant burden on welfare systems and could be a source of social unrest .

In this environment the Euro remains a surprisingly robust currency. Germany’s strong surplus is undoubtedly a factor but the EY  forecast projects a €:$ rate of 1.2 in 2018, too high to support the much-needed acceleration in exports and potentially adding to the deflationary pressures by reducing import prices.

There are also concerns about the possible impact of the results of the Asset Quality Review of the major European banks. An adverse set of findings could further hamper attempts to stimulate lending and credit growth.

…so business should be cautious…

Confidence has improved and there is no doubt that the economic situation in the Eurozone is the best it has been for over 2 years. However, this remains a troubled economic region and the outlook is still weak and fragile. The EY Forecast identifies only 2 sectors that are likely to achieve growth rates of over 2% a year int he coming 5 years: Manufacturing and Communications. Construction will be close to this level but many other sectors will grow at historically low rates. The low rates of consumer spending growth and investment show both how hard it will be for businesses to improve their performance in the coming years, and how challenging the longer term outlook is. If investment remains low and unemployment high, there is  real risk that the productive capacity of the Eurozone and ultimately the value of its market will decline over time.

With the situation more stable than in recent times, now is the perfect opportunity for businesses to evaluate the long-term potential of the Eurozone and to develop the appropriate strategies and operating models without the complexity that crisis mode brings. There are clear pockets of opportunity and signs of improvement but an objective analysis is required to inform medium to long-term decision-making.

..and remind policy makers of their responsibilities.

In my view, the Eurozone policy makers have become a little too relaxed in recent months as we have seen signs of improvement. As discussed above, the Eurozone remains challenged and is facing a long period of difficult conditions and significantly below trend growth. There is more than can be done by policy makers including:

  • Using monetary policy to provide more stimulus and to encourage growth in credit and to adjust the exchange rate;
  • Considering relaxing the speed of the austerity programmes to provide  a short-term stimulus to demand;
  • With the above, specific initiatives to get people, especially young people, into work to avoid  a loss of capability over the medium to long-term; and
  • Identifying ways of stimulating investment, including public infrastructure schemes potentially in collaboration with the private sector.

The crisis is not over and business needs to make clear to policy makers that there is a gap that needs to be filled working in partnership with business.

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