Political tensions take center stage in 2016

Political tensions take center stage in 2016

The Eurozone’s economic recovery continued in the last quarter of 2015, although growth remained soft overall. More complete data showed that GDP expanded 0.3% quarter-on-quarter in Q4, matching the preliminary estimate and mirroring Q3’s result. Solid domestic data continues to drive the recovery, while the external sector dragged on the economy’s performance. Notably, robust growth in domestic demand came on the back of surging investment, while private consumption lost steam. The pick-up in investment suggests that businesses remained confident in the Euro bloc, despite a number of political uncertainties facing the European Union.  

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The Eurozone is facing a number of political conflicts at the outset of 2016, which are threatening to interfere with the region’s recovery and the bloc’s unity as a whole. The United Kingdom will vote on whether to remain in the EU on 23 June and the decision to stay is far from certain. A vote to leave the EU would have significant economic repercussions for both the United Kingdom and the Eurozone. It would also likely to lead to lengthy negotiations and could prompt other member countries to question their affiliation. In addition, the extremely high inflow of refugees into the Eurozone has shaken the bloc at its roots, increasing tensions between nations and leading to restrictions on free movement within the zone—one of the founding pillars of the union. It is far from certain if the recent agreement with Turkey will improve the situation and there is risk of further border controls which could hamper trade flows going forward. On top of this, security concerns have dominated headlines following the recent terrorist attacks in Belgium and could impact tourism going forward.    

Looking at the individual nations, there is large amount of political turmoil as well. Political stalemates are drawing on in Spain and Ireland, where inconclusive elections have left the countries without clear governments.  Meanwhile, in Greece, the country’s future hinges on debt-relief yet negotiations have been delayed by the first bailout review. Bailout talks have been held up as the government grapples with how to plug a fiscal hole; the administration is facing an austerity-weary public and is trying to avoid cutting pensions for the twelfth time since 2010. In France, nationwide protests have broken out in recent weeks over the government’s proposed labor market reform. The bill should help improve France’s competitiveness, however, the government has had to water down a number of measures to appease unions and is facing high rates of public disapproval.        

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Concerns over global headwinds drive down the Eurozone’s outlook 

The Eurozone economy benefited from solid domestic conditions last year as an improving labor market, low oil prices and ultra-loose monetary policy fueled an acceleration in GDP growth. While these conditions are expected to remain in place this year and will continue to fuel the bloc’s recovery, uncertainties regarding the global economy are limiting growth prospects. Weak prospects in emerging markets will likely hamper demand for Eurozone exports this year and last year’s positive impetus from a weaker euro should fade. Against this backdrop, analysts polled by FocusEconomics cut the outlook for the Eurozone economy by 0.1 percentage points and now see growth of 1.5% in 2016. Looking forward to 2017, growth is expected to inch up to 1.6%.

Regarding the economies in the Eurozone, analysts cut their 2016 economic projections for 9 of the 19 countries in the region, including major players Germany and Italy. Meanwhile, analysts’ forecasts were more positive for five countries, while GDP growth forecasts were maintained for five economies, including France and Spain

GERMANY | Government unveils balanced fiscal plan for 2017

Germany’s economy remained on robust footing overall at the start of the year following 2015’s solid performance. Positive signs can be seen in January’s sizable expansion in industrial production, fairly robust PMI readings throughout Q1 and broadly-stable consumer sentiment in the first four months of the year. However, January’s contraction in exports and soft business sentiment readings in February and March give some reasons for caution. Meanwhile, the fiscal plan for 2017 was approved in March. The plan envisages another balanced budget while also increasing spending, particularly on refugees. In the political arena, the result of the 13 March local elections in three states has been seen as a protest vote against the government’s handling of the refugee crisis. While both parties of the ruling coalition lost votes, far-right and anti-immigration party Alternative for Germany (AfD) notably gained support.

Domestic demand will likely continue to be the main pillar of the economy this year, while exports are expected to moderate due to a challenging external environment. Government consumption in particular will strengthen further due to increased spending on refuges. Solid private consumption and increasing construction activity will also support growth. Our panelists see GDP expanding 1.6% in 2016, which is down 0.1 percentage points from last month’s forecast. For 2017, analysts also expect 1.6% growth.  

FRANCE | Labor reform prompts widespread strikes

Massive strikes over the labor reform law the government has proposed brought the French capital and other important cities to a standstill last month. Labor unions and students alike staunchly oppose the watered down law that they deem will undermine worker’s rights and job security. The government argues that the reform is necessary to reinvigorate the economy and cap high unemployment. However, analysts claim that the reform is shortsighted and does not address crucial aspects necessary to make the labor market more flexible. The strikes come amid signs that the French economy remained sluggish during the first months of 2016. While industrial production tallied a healthy expansion in January and the composite PMI returned to expansionary territory in Marchconsumers and businesses alike felt less optimistic in March amid growing global economic uncertainties.

A weak euro and low energy prices are expected to keep France on a modest but steady pace of recovery, yet the country’s rigid and highly-regulated labor market will continue to weight on growth unless structural reforms are implemented. FocusEconomics panelists expect the economy to expand 1.3% in 2016, which is unchanged from last month’s forecast. Panelists expect GDP to grow 1.5% in 2017.

ITALY | EU warns that budget may violate fiscal rules

Italy’s economy expanded for the first time in four years in 2015, albeit at a meagre 0.6%. The economy lost some momentum in Q4, mainly due to de-stocking. In 2015 as a whole, investment returned to growth after declining for seven consecutive years and private consumption picked up. The latest indicators paint a mixed picture of the state of the economy: while consumer confidence improved slightly in March over the previous monthbusiness confidence fell to its lowest level in over a year. Unemployment rate increased slightly in February and the PMI manufacturing index rose in March. Last month, the EU declared that Italy’s fiscal stance has deteriorated since last assessed in November, thus generating risks of deviating from EU fiscal targets. Further political pressure was put on the Italian government on 31 March when the Minister of Economic Development resigned as evidence emerged that she may have shared confidential inside information.

The broad-based recovery in the Euro area and the ECB’s March decision to ease financing conditions should be mildly supportive to growth. On the other hand, weaker demand globally—especially from China—and ongoing financial market instability could hold back growth. FocusEconomics panelists expect the economy to expand 1.0% in 2016, which is down 0.2 percentage points from last month’s forecast. For 2017, the panel sees economic growth at 1.2%.

SPAIN | Sanchez loses vote to become Prime Minister; political stalemate draws on 

Spain outperformed its regional peers last year and the economy expanded 3.2%, which more than doubled growth in 2014. The encouraging figure was mainly driven by robust domestic demand, in particular from strong private consumption supported by increased purchasing power and an improvement in labor market conditions. More recent data point to a continuation of the positive momentum in Q1. In February, retail sales expanded at the fastest rate in several years and the PMI improved. On the political front, the deadlock that followed December’s inconclusive elections continues. In early March, Parliament voted against Socialist leader Pedro Sanchez becoming the new prime minister. Sanchez is now trying to lure the Podemos party into his coalition and failure to reach a deal before the first week of May will likely lead to repeat elections on 26 June.        

Spain’s economic prospects are positive, although prolonged political uncertainty has the potential to undermine growth. 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 growth moderating to 2.3%.

See the Full FocusEconomics Euro Area Report

INFLATION | ECB unveils a comprehensive package of easing measures as consumer prices linger in negative territory

Harmonized consumer prices lingered in negative territory in March, falling 0.1% on an annual basis. The result followed February’s 0.2% decline and comes amid an environment of subdued energy prices. Price pressures have been weak at the outset of 2016 and inflation remains in what ECB President Mario Draghi called the “danger zone” of below 1.0%. Against this backdrop, the ECB announced a comprehensive and widely unexpected package of policy measures to ease monetary condition and stoke inflation on 10 March. The package includes a combination of rate cuts, expansion of the quantitative easing program and a new refinancing program for banks. While the stimulus measures are designed to support economic growth and increase price pressures, analysts are skeptical about whether it will have the desired results and are wondering if monetary policy has reached the limits of its effectiveness.

Inflation is expected to return to the common-currency zone this year, although it will remain timid overall. Even after the announcement of more monetary stimulus, our panel of analysts cut their inflation projections by 0.1 percentage points in April. The Consensus view from our panel of analysts is that inflation in the Eurozone will average 0.4% in 2016. Looking forward, the majority of analysts agree that inflation in the Eurozone will rise gradually and average 1.4% in 2017.

Written by: Angela Bouzanis, Senior Economist

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