investment insights
Fighting back
In a nutshell:
- 2018 saw Eurozone growth fall back behind that of the US, hurt by lower external demand and an auto sector-induced German slowdown.
- Domestic demand nonetheless remains very resilient, on the back of continued labour market tightening, suggesting a pick-up in growth to 2% next year.
- In this context, a normalisation of monetary policy is underway, with asset purchases about to end and negative interest rates to be abandoned by late 2019.
The fact that 2018 GDP growth just shy of 2% is considered disappointing says a lot about how far the Eurozone has come since the crisis years. More meaningful perhaps is to look at growth in relative terms: after slightly outpacing the US in 2016 and 2017, the Eurozone is lagging by more than 1% in 2018 – a marked reversal of the differential.
Examining the numbers in more detail reveals the vulnerabilities at the core of the Eurozone’s current growth model. What stands out first is the reliance on external demand. Having come into the crisis with a small current account deficit, the Eurozone has now built up a very substantial surplus of roughly 3.5% of GDP. This has made its economy dependent on swings in global trade, and in particular on the evolution of demand in its major trade partners.
Having come into the crisis with a small current account deficit, the Eurozone has now built up a very substantial surplus of roughly 3.5% of GDP. This has made its economy dependent on swings in global trade, and in particular on the evolution of demand in its major trade partners.
The second factor worth highlighting is the Eurozone’s dependence on one major engine, namely Germany. This became more evident in recent months as German growth slowed down (indeed contracted in the 2nd quarter). While this development is largely attributable to temporary weakness in the auto sector (due to the introduction of new emission standards), and thus bound to revert, it does illustrate a key Eurozone vulnerability.
The bigger economic picture is, however, one of highly resilient domestic demand (see chart 5). This is what makes us optimistic about near-term Eurozone growth prospects, driving our forecast for a pick-up to 2% in 2019. Even without a substantial trade contribution, the economy is likely to maintain an above-trend pace, as unemployment comes down and income growth improves further (see chart 6). This increasingly normal macroeconomic picture also implies a normalisation of monetary policy. The European Central Bank (ECB) is wrapping up its asset purchases this month, and we expect it to end its negative interest rate policy by late 2019.
The second factor worth highlighting is the Eurozone’s dependence on one major engine, namely Germany. This became more evident in recent months as German growth slowed down due to the introduction of new emission standards…it does illustrate a key Eurozone vulnerability.
Closing on the Eurozone without a word about politics feels incomplete. Yet we see no big threat on that front and tend to view the European Parliament elections as a minor risk event, given that policymaking power remains with national governments. For more “exciting” political risks in 2019 investors may need not look very far: Brexit is scheduled for March and remains wrapped in a cloud of uncertainty
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