Four tailwinds key to Europe’s improved growth prospects
Schroders economists Keith Wade, Azad Zangana and Craig Botham cite four key tailwinds in their improved growth forecasts for Europe
Macro data is on an improving trend in the Eurozone as the monetary union now looks ready to resume its recovery following the pause in the middle of last year. Growth should be bolstered by the recent fall in global energy prices, which at the same time will keep policymakers worried about the risk of long-term deflation.
Hence we find ourselves upgrading growth across Europe once again. Slightly better-than-expected outturns for the fourth quarter have helped, but there are four key tailwinds all contributing to a stronger outlook over the forecast horizon (2015/2016):
1. Oil prices have fallen further over the past three months. As we have discussed in recent months, the fall in oil prices will lower the cost of domestic energy, thereby increasing the amount of disposable income for households, and improving profit margins for firms. This then generates a multiplier effect as those savings are spent through consumption and/or increased investment.
2. The trade-weighted euro has depreciated by 7.1% since our previous forecast in November, providing another tailwind. This will help raise demand for European exports, while domestic producers will see the price of rival imported goods rise. It will also help boost earnings for European-listed companies, where 44% of Eurostoxx50 companies’ sales are from overseas.
3. The banking system is slowly returning to normal activity following the completion of the ECB’s asset quality review and the preceding uncertainty. Banks are now beginning to compete with each other to win new business, which is great news for households and corporates. Borrowers are at last seeing the cuts in interest rates from the ECB feeding through to the effective borrowing costs that they face.
4. The ECB will begin to buy sovereign and agency debt as part of its expanded asset purchase scheme. This should help lower interest rates across the monetary union, but in particular in the periphery, where the monetary policy transmission mechanism has been broken. It could also encourage a further depreciation of the euro, which would be helpful for growth too.
For the Eurozone in aggregate, we have raised our forecast from 0.9% to 1.3% for 2015, versus a consensus of 1.2%. For 2016, we have raised the forecast from 1.4% to 1.6%, against a consensus of 1.7% (chart 7 on next page). On the inflation front, we have lowered the forecast from 0.8% to 0.1% for this year, versus a consensus of -0.1%, while for 2016, we forecast inflation to rise to 1.2%, an upward revision from 1.1%, which is also the consensus.
Inflation is likely to remain in negative territory for the next few months, but as oil prices have already begun to rebound, the negative impact will begin to unwind by the end of the year. There is a risk that households begin to factor in deflationary inflation expectations, however, we feel that this needs a further slowdown in growth in the near-term for it to be a central scenario.
Chart 1: EZ GDP forecast Chart 2: EZ Inflation forecast
Source: Thomson Datastream, Schroders. 20 February 2015. Previous forecast from November 2014.
Within the large member states, we have upgraded all of the forecasts, although more so for the stronger reformers (table 2). For example, Spain is now expected to be the fastest growing economy of the big four over the next two years thanks to continued gains in employment, and stronger activity readings. Germany will also perform well as private and public investment is stepped up, while the household sector continues on its long-term transformation into more prominent consumers. France is likely to struggle this year and next, but the cyclical factors mentioned above will boost activity in lieu of more significant structural reforms. Finally, Italy is likely to emerge from recession in the coming quarters, and eventually begin to enjoy the fruits of the structural reforms being implemented at present.
Table 2: Eurozone GDP forecast
Source: Schroders. 20 February 2015. Previous forecast from November 2014.
Our forecast for the ECB is largely unchanged: we do not expect any changes to interest rates for the foreseeable future, while we expect the ECB to conduct QE at the stated pace of €60 billion per month until September 2016. Due to the liquidity constraints the ECB has introduced, we do not see any room for a further expansion of the scheme.