Euro area: Outlook Drops Again as Hopes of Recovery Falter

Panelists revised down the 2014 GDP outlook for the Euro area for a second consecutive month and now expect the Euro area economy to expand 0.8% in 2014, which is 0.1 percentage points below last month’s projection. The result reflected downward revisions to the outlook for 8 of the 18 economies surveyed (Austria, Belgium, Estonia, Finland, France, Germany, Italy and Latvia). The forecasts for five economies (Greece, Ireland, Malta, the Netherlands and Slovenia) were revised upward, while panelists left the outlook for the remaining 5 economies unchanged. Panelists made a downward revision the 2015 outlook for the first time after five consecutive months of stable projections and cut their growth forecast by 0.2 percentage points to 1.3%.

Ireland Expected to be the Best Performer while Cyprus will be the Worst

Cyprus is expected to be the worst performer in 2014 with a 4.2% contraction, followed by Finland, where panelists project a 0.2% drop. At the other end of the spectrum, Ireland is now forecast to be the strongest performer in 2014 with a 3.6% expansion, followed by Latvia with a 3.1% increase. Panelists revised the forecast for Ireland up by a hefty 0.9 percentage points over last month’s projection after incorporating into their projections the impact that Ireland’s Central Statistical Office’s adoption of the new EU rules on calculating economic output. The new rules added a sizable chunk to the Irish GDP by including spending on research and development along with illegal activities. Looking at the major economies in the region, Germany is still expected to grow the fastest with a projected 1.6% expansion. That said, this is the second month in which panelists have downgraded the country’s outlook. Panelists expect that this year Spain will expand 1.2% and that France will grow 0.6%. Italy’s growth forecast was revised down for the fifth consecutive month and the economy is now expected to contract 0.1%.

Euro Area Recovery Still Weak

The release of more detailed GDP estimates for the Euro area confirmed that the economy stalled in the second quarter. The result raises concerns that the region’s already feeble recovery may be faltering; the economy ground to a halt even before any impact was felt from the recent tit-for-tat sanction escalation with Russia over Ukraine. Euro area GDP was driven by a slowdown in domestic demand that was fuelled by a contraction in investment. More recently, industrial production data provided a tiny glimmer of hope as production expanded 1.0% over the previous month in July, thus recovering from the 0.3% drop recorded in the previous quarter and marking the best result in the last four months.

Eurozone to Face a Challenging Period in the Near Future

Survey-based indicators, however, suggest that the Eurozone will face a difficult period in the months to come. Consumers and businesses are growing increasingly pessimistic regarding the developments in the region. The Markit Composite PMI Output Index flash estimate slowed to 52.3 in September. The reading came in below the 52.5 recorded in August and represented the lowest level since December 2013. Nevertheless, the index has been in expansionary territory for the last fifteen months. Meanwhile, the Economic Sentiment Indicator (ESI) published by the European Commission fell to 99.9 points in September, marking both a moderation over the 100.6 points recorded in August and the lowest reading since November of last year.

ECB Announces Monetary Stimulus to Improve Economic Situation

Within this setting, the ECB announced further monetary stimulus at its 4 September meeting in aim to spur credit growth, fight low inflation and prop up the Eurozone economy. Aside from cutting the key policy rates further, the ECB also launched a plan to conduct large-scale purchases of asset-backed securities (ABS). In parallel to ABS purchases, the ECB will purchase euro-denominated covered bonds. Details on the program—in particular the size of the purchases and the sectors to be included—will be revealed at the next ECB meeting set for 2 October.

Analysts Speculate on ECB’s Next Moves

Market analysts’ reaction to the ECB’s decision has been mixed. Skepticism centered around whether the ECB will be able to buy enough assets to have a meaningful impact on the economy. While Draghi has not provided details on the size of the purchases, he hinted in other statements at the fact that, by combining the long-term TRTLO loans launched in June and the ABS and covered bond purchases, he aims to expand the ECB’s balance sheet by around EUR 1 trillion. However, the uptake of the first TLTRO bid in mid-September was quite disappointing. In addition, the current market for the safe type of ABS securities that the ECB intends to buy is limited in size. Against this backdrop, many analysts believe that the ECB will, at some point, adopt Fed-style quantitative easing and conduct purchases of sovereign bonds. This is a strategy that Draghi has not excluded should the outlook for inflation to deteriorate further, although he faces strong opposition on this issue from some ECB Governing Council members.

France and Italy Struggle to Implement Structural Reforms

Draghi’s decision comes at a difficult time for France and Italy, two of the biggest economies in the region that are struggling to implement key structural reforms. In France, Prime Minister Manuel Valls’ revamped government is struggling to find support for its ambitious EUR 21 billion spending reduction plan. The government barely passed a vote of confidence on 16 September, which showed that only a thin majority in the Parliament supports the Prime Minister’s plan. The difficulties of reining spending amid an ailing economy were made clear on 10 September, when Finance Minister Michel Sapin announced that the country would not make the 3.0% of GDP fiscal deficit target that was set by the European Union; the 2015 budget shortfall is actually projected to reach 4.4% of GDP.

In Italy, Prime Minister Matteo Renzi faces a similar struggle. In early September, the government announced a labor reform to overhaul Italy’s rigid labor laws. Renzi proposed flexible rules for job contracts, which would make it easier for employers to hire and fire workers. The new proposals would help to tackle the much-disputed dual structure of Italy’s labor market, which separates heavily-protected full-time workers from temporary workers who have few rights. However, trade unions and the left wing of Renzi’s Democratic Party have already expressed strong opposition to the proposed reform.

Euro Area Still in Inflationary “Danger Zone”

Regional annual inflation was stable in August at July’s 0.4%, which is the lowest level that has been recorded since October 2009. The result represented an upward revision to the 0.3% flash estimate that was released at the end of August. Annual inflation has now been in what ECB President Mario Draghi called the “danger zone” of below 1.0% for eleven consecutive months. Taking stock of the recent inflation developments, FocusEconomics Consensus Forecast panelists kept their 2014 inflation projection unchanged at the 0.6% that was expected last month. In 2015, inflation is expected to average 1.1%, which is also unchanged from last month’s projection.

 Note: This is an excerpt from the FocusEconomics Consensus Forecast Euro area – October 2014, published September 30th, 2014. The full report (169 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. (links to landing page)

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