Raising the bar: solid growth has become the norm

In a nutshell:

• The recovery-turned-expansion is firmly in place, even if growth appears to be moderating somewhat from very high levels.
• Few signs of inflation have surfaced as yet, allowing the European Central Bank (ECB) to leave policy changes for later.
• Price pressures are, however, not completely absent, making a monetary shift likely in coming months.

Persistently strong growth in the Eurozone has quelled most remaining doubts as to the sustainability of the recovery. Market participants and policymakers alike have substantially upgraded their forecasts since the fall of 2017 and we remain convinced that 2018 is on track for 2.5% growth. Evidence of the upturn is broad: unemployment is falling, investment is picking up, corporate earnings are rising, and government finances are improving.

Some moderation in cyclical indicators is under way (see chart VI, page 6), which is no surprise given the extremely high levels reached at the end of 2017 – consistent with above-3% annual GDP growth (compared with an estimated potential that barely exceeds 1%). Our outlook nonetheless remains very constructive, with the main drivers of the European expansion still firmly in place: accommodative monetary policy, easier credit conditions, still some spare capacity, a more growth-friendly fiscal mix, and improved external demand.

That said, the Eurozone's “goldilocks" world of strong growth and low inflation may not last that much longer. Survey data show clear signs that supply chains are becoming stretched (see chart VII, page 6), and employers are reporting intentions to raise wages as the labour market continues to heal. The recent wage agreement in Germany between the employers' federation and the metalworkers union was a case in point. As slack erodes further, a pick-up in inflation will become increasingly likely.

Although this process will be slow-moving, we foresee meaningful policy implications during the coming quarters. A crisis framework is now less appropriate for the ECB. Its commitment to quantitative easing runs through September, before which date we expect some clarity to be provided on the future path of action. Our belief is that the ECB will terminate asset purchases by the end of this year and start raising interest rates early in 2019.

Contrary to expectations, political factors have little affected the Eurozone economy over the past year. Euro-centric issues (such as political uncertainty in Italy) and external drivers (notably protectionism) have not vanished – meaning that political risk still bears monitoring. But, unless we see clear signs of deterioration, we expect increasingly solid Eurozone economics to dominate occasionally noisy politics.