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May 04, 2016


On the eurozone's uneven but surprisingly robust recovery

The European Commission's report on the EU economy is quite interesting in some of the details it presents about the eurozone's uneven economic recovery, rather than in terms of the actual numeric forecasts. The latter - which we find less interesting, especially given their record - make the newspaper headlines. They are also not very surprising. 

We are once again in a situation where the hard data and the sentiment indicators diverge. We prefer the hard data, and don't believe that sentiment indicators add much value, not even in terms of "breadth" as the report says. What we know is that the recovery in 2015 Q4 and 2016 Q1 has been more robust than widely predicted, driven by private and public sector consumption, and even a temporary pick-up in investment in the last quarter of 2015. As for 2016, the report notes, consumption is holding up well, based on a 2.5% projected growth of gross disposal incomes which, at zero inflation, should translate into a real income growth of the same magnitude. Other factors included improvements in bank lending conditions for households, rising house prices, and a general strengthening of household balance sheets. The Commission puts 2016 consumption growth at 1.8%. The growth of public consumption was strong in 2015, will still be positive in 2016, and will then decline in 2017 - a hazardous projection that mixes expectations and polices. We are not sure this is true. Given the political trends in southern Europe and the ongoing refugee crisis that affects this area particularly hard, plus the French and German elections, we would not be surprised to see a continued increase in public expenditures in 2017 as well. The Commission is cautious on investment growth. It was strong in Q4, but is now expected to moderate this year - based on some rather pessimistic surveys among investors, which again contrast with some more upbeat hard data on equipment sales and construction.

What is clear, however, is that the weakness in emerging markets is having a negative effect on net exports. So does the recent appreciation of the euro. The dollar-euro briefly reached $1.16 this week. It was back to a little under $1.15 this morning. See below for the trade-weighted nominal exchange of the last two years, which gives a good overview of the initial impact of QE on the euro's e/r, and the slow reversal since.

Source: ECB 

We noted Ambrose Evans Pritchard picking up on comments from the US that the reversal of the tightening in financial conditions in March may make it more likely that the Fed reverts to its original path of interest rate increases. The panic over China has subsided. Commodity prices are recovering. The weak dollar has had a positive impact. If so, that would clearly help the euro's exchange rate.

We also picked up on two comments on the wider economy. Federico Fubini notes that ageing societies, like Italy, Germany, and Japan have a lot of features in common: persistent savings surpluses, low interest rates, and zombie banks. John Plender notes that it can be quite difficult these days to effect a competitive devaluation. He noted that the yen appreciated after the BoJ's announcement of negative interest rates in January. The unwinding of carry trades where the yen was used as a funding currency is, no doubt, part of the explanation, he writes.

Regarding the structural budget balance, it is strongly model-dependent and currently contested, but still a major determinant of fiscal policy. The Commission observes that the reduction of the structural deficit slowed down in 2015 and will reverse in 2016, with the eurozone structural deficit increasing from 1% of GDP in 2015 to 1.3% in 2016. As the Commission still estimates a sizeable output gap one wonders whether the structural deficit is not being overestimated by about 1% of GDP. The Commission observes that the change in the structural balance is not correlated with member states' debt levels, but with their output gap, as countries have a mildly counter-cyclical fiscal stance.

Our other stories

We also have stories on the spending cut mechanism, the bone of contention in the Greek negotiations; on Atlante ending up as the underwriter of underwriters; on the Hungarian refugee referendum; on fiscal-vs-monetary policy as an explanation for the economic slowdown in 2011/12; on whether a TTIP agreement is out of reach; and on Hollande's promise of income redistribution, and why this fails to work.

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