European outlook: show me the money
12 November 2019
By Henk Potts, Senior Investment Strategist
Will 2020 at last be the year when eurozone policymakers stop obsessing with balanced budgets and focus more on fiscal reforms to lift the region’s lacklustre growth prospects?
The significant deterioration in Europe’s growth profile over the past 18 months is sparking fears of a recession in the eurozone in 2020. The single currency bloc’s open, and export-oriented, economies are vulnerable to the slowdown in global growth, trade wars, Brexit uncertainty and the manufacturing recession.
Accompanying the weaker external demand, Europe struggles with a broad range of internal disruptions. These include the “yellow-vest” protests in France and turmoil in the Germany auto sector. Meanwhile, Italy’s budget battle with Brussels in 2019 resulted in subdued investment and held back hiring.
Growth, not recession
While growth rates are expected to remain under pressure, we are not forecasting contraction in 2020. Financial conditions are loose and consumer confidence remains resilient, helped by a falling unemployment rate.
Recent data shows that eurozone unemployment fell to 7.4%, from 12.1% in April 2013, which is the lowest unemployment rate since 2008. Additionally, pay growth is running at its fastest pace in a decade, supporting domestic consumption.
While the US-China trade dispute has grabbed the headlines, President Donald Trump has also been reviewing the US’s relationship with the European Union (EU). While a full-blown US-EU trade confrontation appears unlikely, we still expect flare-ups (particularly US auto tariffs).
While growth rates are expected to remain under pressure, we are not forecasting contraction in 2020.
More dovish policy
The weaker growth backdrop has encouraged the European Central Bank (ECB) to ratchet up its policy response in another effort to stimulate growth, reflate the economy and generate jobs.
The ECB cut the deposit rate to -0.5% in September (see chart). We anticipate further cuts, with the deposit rate at -0.7% by March.
The central bank restarted it asset-purchase programme and introduced measures to mitigate against the impact of negative rates on the banking system in 2019. Along with these measures, the ECB has offered aggressive forward guidance and promised to keep rates low, or lower, until inflation persistently converges with its 2% target level – an objective that is unlikely to be achieved for the next few years.
The ECB’s measures, while supportive, are unlikely to be enough to radically change Europe’s lacklustre growth trajectory in 2020. Former ECB president Mario Draghi acknowledged this and encouraged Europe’s political leaders to commit to the structural reform agenda and fiscal support.
A wide-ranging package of structural reforms is required to promote growth and supplement monetary policy. These should include further integration of Europe’s budget, fiscal and banking functions. Europe should also focus on increasing the flexibility of the labour market. It needs to create a more competitive environment that drives up productivity.
Early signs of possible fiscal support appear encouraging. Germany has announced plans to invest in a new climate change package and the Netherlands has announced tax cuts. However, the lack of coordination or size of proposals is not currently enough to materially improve growth forecasts.
If European governments are determined to generate growth, they need to spend less time obsessing about balancing the books and devote greater effort to the reform schedule.
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