Two of Europe’s long-awaited events have finally happened. The eurozone is out of recession, permitting the possibility of an eventual stabilisation in government debt burdens and some corporate top-line growth. Secondly, the German election has finally happened. Once Angela Merkel forms a new coalition, decisions can be taken on key eurozone-related issues including additional aid for Greece and Portugal, closer EU integration and faster progress on banking union.
We expect the economic recovery that began in the second quarter of 2013 to continue. Indeed, for the first time in two years the revisions to our forecasts are upward. However, they are modest and we still expect a 0.3 per cent contraction in the eurozone for 2013 and 1.3 per cent growth in the UK. So we are expecting a feeble recovery and our 0.8 per cent forecast for eurozone growth for 2014 primarily reflects a higher projection for Germany.
The recovery still seems set to be mainly export-led, so global demand is important. But although the situation in some emerging markets is not encouraging, the eurozone does not have a high direct exposure to India, Brazil, Indonesia, Turkey and South Africa. Much more important is demand from the US, other Asian and African countries, plus intra-European trade.
We expect the economic recovery that began in the second quarter of 2013 to continue
So with exports driving any momentum, the growth profile is set to be fairly cyclical over the next two years, even if the deep consumer recessions are largely over and private-sector employment growth appears to have turned the corner, boosting consumer confidence.
However, it is also clear that growth has been bolstered by stronger government spending, which for the periphery will go into reverse before the end of 2013.
So we have our doubts about the sustainability of a domestic recovery. Investment and consumer spending are likely to show ongoing divergence across the region with Germany and the UK set to do better than most.
France could still maintain reasonable consumption growth and a housing market recovery – not because of positive employment and real wage growth, like Germany, but because of ongoing government transfers and lending to the housing market.
And there are signs that even some of the periphery’s housing markets are over the worst. In Ireland, where house prices halved, employment is now growing and mortgage approvals have revived strongly. However, in Italy and Spain bank lending remains very subdued for households and companies.
Weak growth, low inflation and potentially higher rates are not a combination that will lead to stabilising government debt burdens. But since the “whatever it takes” speech by European Central Bank President Mario Draghi missed deficit targets and growing debt stocks no longer shock a market comforted by knowing that, if necessary, the bank will save the day with bond purchases.
One risk is the impact of US Federal Reserve tapering of quantitative easing on financial stability, market rates and credit availability. But even if we think the ECB should reinforce its forward guidance by cutting its refinancing rate again, that’s unlikely before 2014.
Another risk is complacency among eurozone politicians who either no longer see the imperative of closer integration or have told voters the recession and the crisis are over, ignoring the further austerity that still lies ahead. And political risks remain, especially when governments in Portugal, Spain, Italy and Greece have slim majorities in parliament and/or low popularity.
This research was first published on 1 October 2013.