Eurozone recovery continues, but political risks linger on the horizon
March 3, 2016
The Eurozone economy grew steadily in the last quarter of 2015, continuing the modest pace of recovery seen in the previous quarter. According to a preliminary estimate, Eurozone GDP increased 0.3% quarter-on-quarter in Q4, which matched Q3’s pace of growth. Although detailed data covering the breakdown of components is not available yet, Q4’s expansion likely came on the back of solid domestic data while the external sector is expected to have performed sluggishly. Consumption continues to be propelled by low inflation, an improving labor market as well as by favorable financing conditions. On the other hand, sluggish external demand—particularly from emerging economies—is likely to be keep the Eurozone recovery stuck in a low gear and poses one of the main challenges to the growth outlook going forward.
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The other key challenge to the region’s outlook is political turmoil. In both Ireland and Spain, divided parliaments are threatening to bring government actions to a standstill as coalition negotiations take center stage. Preliminary results for Ireland’s 28 February general election depict the most fragmented parliament in Irish history, as voters frustrated with years of austerity turned away from traditionally-dominant parties, setting the stage for tough coalition negotiations and potentially a second round of elections. The result mirrors Spain’s situation, where the country has been without a government since December’s fragmented election result. Pedro Sánchez, leader of the Spanish Socialist Workers’ Party (PSOE), will face the first vote of confidence for Prime Minister on 2 March, however, it is unclear whether he has the support needed to win the vote. In addition, political risks linger in Greece, where the first review of the bailout has been delayed due to slow implementation of reforms, and in Portugal, where the government is stuck walking a tightrope between demands from far-left allies and the European Commission’s fiscal consolidation rules.
On a broader scale, the United Kingdom will vote on its future in the European Union on 23 June following successful negotiations between UK Prime Minister David Cameron and EU leaders. The parties struck a deal aimed at keeping the UK in the EU by giving it special status in key areas such as immigration, sovereignty, economic governance and competitiveness. While at this point most analysts expect the UK to remain in the EU, early polls point to a tight race. A country leaving the EU is unchartered territory with huge uncertainties regarding the economic consequences. Against this backdrop, the FocusEconomics panel expects the Eurozone’s economy to expand 0.4% over the previous quarter in Q1 2016.
Growth expected to remain broadly stable in 2016
The Eurozone economy picked up pace last year as healthy consumption led to a 1.5% increase in GDP, the strongest growth seen since 2011. The conditions that led to last year’s recovery remain largely in place and the economy is expected to record another healthy expansion in 2016. Bright consumer spending prospects on the back of low oil prices, muted inflation and an improving labor market will support growth this year. However, the pace of expansion will remain moderate overall as slower economic growth in key emerging economies weighs on the external sector and political risks linger. Against this backdrop, analysts polled by FocusEconomics kept the outlook for the Eurozone economy stable this month and see growth of 1.6% in 2016. Looking forward, the Eurozone economy is expected to maintain that pace of growth in 2017 and is seen increasing 1.6%.
Looking at the economies in the Eurozone, analysts maintained the 2016 economic outlook for 6 of the 19 countries in the region. Analysts cut the GDP growth forecasts for 11 economies, including major players France, Germany and Italy. Ireland and Luxembourg were the only countries for which the forecast was raised.
GERMANY | Strong domestic dynamics fuel pickup in growth and fiscal surplus in 2015
Germany’s economy performed solidly in 2015. GDP expanded at a steady quarterly pace of 0.3% in Q4, bringing growth for the whole year to 1.7%. Last year’s slight uptick over 2014 mainly resulted from exceptionally strong private consumption, which was buttressed by a buoyant labor market, cheap oil and low inflation. Public spending also rose, partly due to higher expenses related to the surge in refugees. Conversely, fixed investment and exports remained a weak spot. Moreover, Germany recorded a fiscal surplus for the second consecutive year and public finances were bolstered by higher income tax revenues and several one-off effects. More recent data, however, point in diverging directions. February’s drop in both business confidence and in the PMI suggest a loss of momentum, particularly in the manufacturing sector. By contrast, March’s rise in consumer confidence underlines that private consumption is a robust growth engine.
Solid domestic dynamics are expected to keep growth on track and to compensate for slowing exports this year. Factors underpinning growth include the strong labor market, still-low oil prices, accommodative monetary policy and rising public spending due to the influx of refugees. However, weakening external demand resulting from slower global growth poses a downside risk. Our panelists see GDP expanding at a steady pace of 1.7% in 2016, which is down 0.1 percentage points from last month’s forecast. For 2017, analysts also expect 1.7% growth.
FRANCE | Economy improves in 2015, but still lags behind regional peers
France’s economy grew at its fastest pace in four years in 2015 and met the government’s target. The acceleration came primarily on the back of stronger domestic demand, with private consumption growing at the fastest rate since 2010. However, the French economy is still lagging behind the average growth rate of Eurozone countries and unemployment has been steady at over 10% for three years. Latest indicators signal that the economy likely lost momentum at the start of 2016. Indeed, in February, the composite PMI fell below the threshold that separates contraction from expansion and consumer confidence dropped to a six-month low.
While a weak euro and low energy prices are expected to keep France on a modest but steady pace of recovery, its rigid and highly-regulated labor market will keep weighing on growth unless structural reforms are implemented. FocusEconomics panelists expect the economy to expand 1.3% in 2016, which is down 0.1 percentage points from last month’s forecast. Panelists expects GDP to grow 1.5% in 2017.
ITALY | Slow pace of growth presents challenge for Government
Italy’s economy expanded for the first time in four years in 2015. However, growth undershot the government’s target and the economy showed signs of moderation in Q4 over the previous quarter in seasonally- and working-day adjusted terms. Latest indicators paint a mixed picture of the economy at the start of 2016: While consumer confidence fell to a five-month low in February, business confidence partially recovered from the previous month’s drop. Slower-than-expected growth might become a significant challenge for Prime Minister Matteo Renzi, who has ambitions to balance Italy’s books while easing austerity measures. Renzi is already engaged in a clash with the European Commission regarding Italy’s 2016 budget. Further, he has been calling for more flexible fiscal rules and cost sharing to mitigate the migrant crisis, which is weighing on the government’s tight budget.
While a broad-based recovery in the Euro area should lead to modest but steady growth, China’s slowdown and rising geopolitical uncertainty within the European Union have caused downside risks to increase. FocusEconomics panelists expect the economy to expand 1.2% in 2016, which is down 0.1 percentage points from last month’s forecast. For 2017, the panel sees economic growth at 1.2% as well.
SPAIN | PSOE inks deal with Citizens in attempt to end political deadlock
Spain’s economy, underpinned by robust domestic demand, accelerated last year and grew at the fastest pace since 2007. Surging private consumption, supported by a multi-year-low unemployment rate and falling prices, has put the country on a growth path following years of recession. On the political front, two months after the most fragmented election in recent history, a clear government has yet to take shape. The Socialist Workers’ Party (PSOE)—the runner-up in December’s election—is beginning to build support to form a government and, in February, PSOE inked a coalition deal with the newcomer Citizens. However, the alliance falls short of a majority in parliament and it is not known whether PSOE’s leader, Pedro Sánchez, can pass the 2 March vote of confidence for Prime Minister.
Despite the uncertain political situation, Spain’s growth prospects are stable. The FocusEconomics panel sees the strong growth momentum continuing this year and expects the economy to grow 2.7% in 2016, which is unchanged from last month’s forecast. For 2017, the panel sees the growth moderating to 2.3%.
INFLATION | Consumer prices fall in February, supporting case for additional monetary stimulus
Harmonized consumer prices fell back into negative territory in February, swinging from a 0.3% annual increase in January to a 0.2% fall. Inflation remained stubbornly low in 2015 mainly due to the marked decline in energy prices, and, at the start of 2016 price pressures appear weak and inflation remains in what ECB President Mario Draghi called the “danger zone” of below 1.0%. The subdued reading has strengthened expectations that the ECB could increase monetary policy stimulus at its next meeting in March.
Following zero inflation in 2015, price pressures in the common-currency zone are expected to return this year, although they are seen remaining subdued overall. The Consensus view from our panel of analysts is that inflation in the Eurozone will average 0.5% in 2016. The projection was cut by 0.2 percentage points from last month’s Consensus. Looking forward, the majority of analysts agree that inflation in the Eurozone will gradually return to levels that are below, but close 2.0%, and average 1.5% in 2017.
Written by: Angela Bouzanis, Senior Economist
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