No sustained downturn

In a nutshell

• The economic softness recorded year-to-date does not herald a sustained downturn.
• The ECB made a number of announcements at its June meeting, understandably perceived as dovish by market participants.
• Fiscal slippage, rather than insolvency, is the risk in Italy.

After experiencing some of its strongest growth rates in at least a decade, the Eurozone economy took a breather during the past few months. Fortunately, the latest set of macro data provides reassurance that the softness recorded in early 2018 does not mark the start of a sustained downturn.

Instead, European economies continue to benefit from their return to above-trend growth, with a number of fundamental drivers still in place. Rising employment, strong confidence, accommodative financial conditions, recovering trade and investment, and solid corporate profitability all suggest that the ongoing recovery has further to run. Some inflation is also finally materialising, with the core Harmonised Index of Consumer Prices (HICP) surpassing 1% recently, and wage growth also starting to show encouraging signs (see chart VI).

The European Central Bank (ECB) continues to provide support to the economy, even if its monetary policy stance is clearly shifting towards less accommodation. The monthly amount of asset purchases will be reduced once again in September, continuing at a lower pace of EUR 15 bn until quantitative easing in all likelihood comes to an end in December (see chart VII). The ECB has also extended its forward guidance on interest rates, effectively committing to keeping them unchanged at their current low levels through September 2019. While this development came as a dovish surprise to market participants, who were expecting a somewhat earlier “lift-off”, the process of interest rate normalization remains our base case and we expect to see an end to Negative Interest Rate Policy in the Eurozone by December 2019.

As regards political developments, we should stress that Italy of 2018 is not Greece of 2011. Current accounts of countries in the Eurozone periphery, including Italy, have since moved into surplus, eliminating concerns about solvency – and hence a repeat of the sovereign debt crisis. Notwithstanding a new government formed of non-mainstream parties, polls do not signal a voter bias towards leaving the Eurozone or European Union (EU), nor is there any intention for such a question to be submitted to the public. Rather than an exit from the euro, the risks that we would focus on in Italy have to do with fiscal slippage and the country’s relationship with other EU members.