Europe’s Economic Outlook Deteriorates

The 2014 GDP outlook for the Euro area deteriorated this month following two months of stable projections. FocusEconomics panelists expect the Euro area economy to expand 0.9% in 2014, which is down 0.2 percentage points from last month’s projection. The result reflected downward revisions to the outlook of 7 of the 18 economies covered (Austria, Belgium, Finland, France, Germany, Italy and Portugal). The forecasts for four economies (Cyprus, Ireland, Slovenia and Spain) were revised upward, while panelists left the outlook for the remaining 7 economies unchanged. Panelists expect the Euro area economy to expand 1.5% in 2015; this projection has been stable since May.

Cyprus will be the Worst Performer, while Latvia will be the Strongest

Cyprus is expected to be the worst performer in 2014 with a 4.2% contraction, followed by Finland, where panelists project flat growth. At the other end of the spectrum, Latvia is forecast to be the strongest performer in 2014 with a 3.5% expansion, followed by Ireland (2.7%). Despite experiencing the first downward revision since June 2013, Germany is still expected to be the fastest growing major economy in the region with a projected 1.8% expansion. Panelists expect that Spain will expand 1.6% and that France will grow 0.6%. Italy is expected to experience a meager 0.1% expansion. This marks the fourth consecutive downward revision to Italy’s growth forecast.

Euro area Growth Flat in Q2, Undershoots Market Expectations

This month’s downgrade to the Euro area outlook came on the back of a dismal Q2 GDP release. The Euro area economy recorded flat growth over the previous quarter in Q2. The result undershot market expectations and marked a moderation compared to the meager 0.2% expansion recorded in Q1. The result raises concerns that the already feeble recovery in the region may be faltering as the economy ground to a halt before any impact was felt from the recent tit-for-tat sanction escalation with Russia over Ukraine. At a country level, the reading was underlined by a poor performance of the German economy, which contracted 0.2% over Q1 and marked the first quarterly drop in over a year. On a positive note, Spain recorded its strongest result since Q4 2007 with a quarterly expansion of 0.6%.

Gloomy Outlook Adds to Bleak GDP Data

Additional indicator releases corroborated the bleak picture presented in the GDP data. Industrial production contracted 0.3% over the previous month in June, which marked a second consecutive drop. Meanwhile, the unemployment rate remained stable in July at the 11.5% recorded in the previous month (the lowest level since September 2012). Nevertheless, unemployment is still hovering close to the region’s all-time high of 12.0 %.

Russia and Ukraine Tension Affects Europe’s Economy

Survey-based indicators suggest that the Eurozone will face a difficult period in the months to come as consumers and businesses begin to factor in the likely impact that geopolitical tensions in Russia and Ukraine will have on the region’s economy. The Markit Composite PMI Output Index flash estimate slowed to 52.8 in August. The reading came in below the 53.8 recorded in July and brought the PMI back down to the year-to-date low last recorded in June. Nevertheless, the index has been in expansionary territory since July of last year. Meanwhile, the Economic Sentiment Indicator (ESI) published by the European Commission fell to 100.6 points in August, marking a moderation over the 102.1 points recorded in July. August’s result wiped out the gains recorded in recent months and economic sentiment now sits at the lowest level that has been recorded this year.

Russia Retaliates Against the West’s Sanctions

The confrontation between Russia and the West—and Europe in particular—continues to occupy center stage in the political arena. At their most recent meeting on 30 August, European leaders gave Russia one week to scale back intervention in Ukraine or face further sanctions as allegations mount that Russian forces illegally crossed the Ukrainian border to support pro-Russian separatists. At the end of July, European authorities imposed sanctions that included the energy sector for the first time. This decision marked a step up compared to the largely symbolic measures that were adopted at the beginning of the Russian-Ukraine crisis. In retaliation, Russia implemented a ban on imports of food from Europe and other Western trading partners.

Hollande Shakes Up Cabinet, Portugal Bails Out 2nd Largest Bank

In France, President Francois Hollande decided to reshuffle his cabinet on 25 August against a backdrop of stalled economic growth and cabinet members’ dissent over the government’s economic policy. This is the second time Hollande has reshuffled his cabinet this year and the fourth during his administration. Meanwhile, Portugal’s second-largest bank, Banco Espirito Santo, was bailed out and broken up on 4 August. The failure of the bank raises questions over whether more troubles are concealed within Europe’s banking sector.

Euro area Economy Threatened with Deflationary Scenario 

Inflation dropped further this month, stoking fears that the Euro area may enter a growth-threatening deflationary scenario. Annual HICP inflation came in at 0.3% in August, which was down from the 0.5% recorded in July and marked the lowest inflation rate since October 2009. Inflation has been within what ECB President Mario Draghi called the “danger zone” of below 1.0% for ten consecutive months.  Draghi acknowledged at the 20-21 August meeting of central bankers in Jackson Hole that financial market indicators which track inflation expectations have reached worrying lows. He stated that this assessment will be integrated into the next set of ECB inflation projections, which will be released at the next ECB meeting scheduled for 4 September. Against this backdrop, expectations are mounting that the ECB may announce further accommodative measures—in particular large-scale purchases of public and private assets—as next meeting.

Taking stock of the recent inflation developments, FocusEconomics Consensus Forecast panelists cut their 2014 inflation projections by 0.1 percentage points from the 0.7% expected last month to 0.6%. In 2015, inflation is expected to average 1.1%, which is also down 0.1 percentage points from last month’s projection.

Note: This is an excerpt from the FocusEconomics Consensus Forecast Euro area – September 2014, published September 2nd, 2014. The full report (171 pages, covering all 18 Eurozone member states is available for immediate download at the FocusEconomics Online Store). For more information and a free sample of the report please visit our website.

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