Every year, the Financial Times polls some of the top economists to ask about likely developments in the Eurozone economy the year ahead. Our managing director Sony Kapoor has been asked to contribute for the past few years, and the detailed prognosis for 2019 from all of the economists polled has been published by the FT here.
So, what should we expect in 2019?
The Eurozone is likely to experience slower, but still above potential growth, likely to be in the vicinity of 1.7%. There will be headwinds from an end to more QE, stagnating global trade, a rising euro, political risks in France, Italy and from a possible Brexit, slowing global growth, and Trump’s unpredictable trade war.
However, these will be balanced out by the tailwinds from continuing cyclical recovery, robust domestic demand, easy monetary conditions, mild fiscal expansion, and falling unemployment. There do remain greater risks of a downside surprise.
Moreover, core inflation in the Eurozone has been remarkably sticky at low levels and despite low unemployment and potential wage pressure in some Eurozone economies, the region as a whole continues to have significant slack and is still in the recovery phase after the trauma of the Eurocrisis. Unemployment should fall further, setting the scene for a gradual normalisation of inflation, but not in 2019 when the ECB will, despite continuing easy monetary policy, still not meet its inflation target. Core inflation in particular, will undershoot the ECB’s target, yet again and is likely to be around 1.6%.
The European parliament elections
Meanwhile, the European Parliament elections are likely to deliver the most fragmented Parliament yet, with the highest share yet for populists of the left and right, and a shrunken centre-ground. This will undoubtedly make decision-making at the EU level more difficult over the term of the Parliament, but is unlikely to have any significant negative impact on the Eurozone economy in the near term.
Eurozone reform and resilience
The scope of Eurozone reform enacted so far has been limited, even though real tangible progress has definitely been made. Doom mongers continue to predict a demise of the euro even as it celebrates its 20th anniversary. That is why it is critical to remember that the Eurozone has proven remarkably resilient against both external and internal economic, financial and political threats.
This resilience will continue even as new threats emerge from within and without. Eurozone leaders are still failing to address longer term structural issues satisfactorily and the monetary, fiscal and political space to confront the next crisis in the Eurozone is more limited than last time, even if the crisis response and policy tools have been mapped out more effectively this time. It is irresponsible to waste the space accorded by benign financial, fiscal and monetary conditions not to set the Eurozone’s house in order and we may come to regret it when the next big shock hits.
The Italian economy was recovering and reforming, albeit slowly, when the current populist regime took over. Their unpredictable, often populist and anti-EU rhetoric has dented business and investor confidence and domestic investments even though actual policy reversals and changes have been more limited. Rising sovereign bond yields in an environment of still-fragile banks and large domestic holdings of sovereign bonds also depress growth.
Overall, we should expect Italy not to have a crisis, at least in the near-term, and expect growth to continue. Albeit, this will happen at a slower pace and amidst greater volatility. There will definitely not be an Italy exit from the Euro, not in 2019, and probably not ever.
Macron’s concessions, despite big headlines, are relatively modest in their macroeconomic significance. They are likely to have only a limited economic impact on 2019, and it might even be modestly expansionary and raise consumer spending, particularly if the European Commission goes easy on France’s fiscal deficit.
But the concessions do signal a weakened Macron, while diminishing his authority at home and within the Eurozone. If he recovers from this, France’s and the Eurozone’s economies will get a small boost. But even if he does not, he still has the opportunity to use his majority in the Parliament to do a whole lot of good on structural reforms, even if he loses the next election.
At another level, his weakness at home may just make Germany and the hawkish Hanseatic league countries more conscious of the limited window to get serious Eurozone reforms agreed. It might make them more amenable to some of Macron’s many sensible suggestions for Eurozone reform that Germany has thus far resisted. That will be good for the Eurozone economy, particularly in the long-term.
The Eurozone is one of the largest exporters in the world, with economies such as Germany particularly dependent on exports as an engine of growth. The year 2017 provided a benign combination of a cheap currency, a growing rest of the world and rising exports to provide a boost to Eurozone growth, while 2018 was less benign, but still positive.
In 2019 we could still see rising net exports contributing to Eurozone growth, particularly if the oil price remains subdued, but dark clouds are gathering on the horizon with a trade and tech war between China and the US looming. If this escalates, the Eurozone will undoubtedly get caught in the cross-fire and suffer. Worse, unpredictable Trump, who famously does not like the EU, may turn his guns more directly on the EU and launch a renewed trade war that will depress exports and growth in the Eurozone. On the plus side, the EU’s landmark trade deal with Japan should give trade a much needed shot in the arm.
If the UK does quit the EU, how will it affect the eurozone?
The UK is increasingly unlikely to quit the EU and Brexit, at least from my perspective, will now almost certainly need to be called off. If this does happen, it may provide a short-term boost to the UK and Eurozone economy by removing a major risk and damper on business and investor confidence.
If the UK does leave however, it will be negative for Eurozone growth too with the degree of drag on growth determined by the terms of exit. The main damage will be inflicted on the UK itself with growth in Eurozone dented at most by a fraction of a percentage point in 2019.
In the longer term, however, Brexit may actually benefit the Eurozone as investment, trade and entrepreneurs exiting the UK end up boosting the Eurozone economy.