The FINANCIAL -- The Eurozone recovery is expected to gain momentum gradually after near-stagnation in the first six months of the year. GDP will grow by 0.9% this year, before picking up to 1.5% in 2015 and 1.7% in 2016. After two years of falling output, the recovery is welcome, but the pace of growth will remain substantially lower than the pre-crisis average of 2.3% a year in 1997 through 2007, according to the September 2014 issue of EY Eurozone Forecast (EEF).
On a more positive note, unemployment in the Eurozone has now stopped rising. Although the decline in the jobless rate is expected to be gradual, falling from the current 11.4% to 10.9% by the end of 2016, this development will still improve consumer confidence. Furthermore, the moderate recovery of real disposable income, expected to rise 1% in 2015 and 1.4% in 2016, should drive increased consumer spending.
Encouraging signs also come as a result of ongoing healing in the financial sector, with survey measures suggesting credit constraints are easing, and support for lending to business likely to result from the European Central Bank’s targeted longer-term refinancing operation (TLTRO) program. This, combined with modestly strengthening economic activity and the weakening of the euro, means that deflation should be avoided. However, the Eurozone will experience a prolonged spell of low inflation, given continued significant spare capacity in the labor market and the need for further deleveraging among firms, households and governments, according to EY.
“Putting aside a second quarter that was distorted by temporary weather effects, the recent data confirms a gradual improvement in the Eurozone. But the fragility of the recovery underlines the need for vigilance among fiscal and monetary policymakers, while continued reform efforts will be needed to make it more attractive for firms to invest and create jobs,” Tom Rogers, Senior Economic adviser to the EY Eurozone Forecast said.
“Even though unemployment rates remains high, labor markets in many Eurozone countries do seem to be at a turning point. This is to be welcomed, both from a social perspective and because of the impact this is having on consumer confidence and consumption. Nevertheless, substantial risks to the recovery still exist—in particular from geopolitical events that have the potential to undermine global business confidence and trade flows,” Mark Otty, EY Area Managing Partner for Europe, Middle East, India and Africa, said.
Structural factors may hinder a faster upswing in France, Italy and Greece. In Portugal, Ireland and Spain, sharp cuts in unit labor costs and ambitious labor market reforms have boosted export market shares, in contrast to France and Italy where competitiveness has deteriorated, according to EY.
In Germany and Spain, investment growth of 2.5% and 1.1% respectively is expected in 2014, whereas companies in France and Italy are continuing to cut their capital spending. Moreover, lackluster GDP growth of 0.4% expected in France for 2014 and the 0.2% contraction expected in Italy contrast with the projected 1.3% recovery in Spain and 1.5% growth in Germany. Ireland is also expected to see a particularly robust rise in GDP of 2.8%.
Over 2015-16, the difference in the pace of recovery across core Eurozone countries is forecast to narrow but the gap created over the long-term will persist. Growth prospects in Greece and Cyprus, together with Finland and Italy, appear particularly vulnerable to both domestic and external shocks, according to EY.
The early stages of the recovery were largely driven by an improving trade performance, but domestic demand is expected to play a larger role in the years to come. That said, the recent depreciation of the euro will help exporters, particular in the less competitive economies – exports are expected to grow by around 3% in 2014, picking up to 4.1% in 2015 and then 4.3% in 2016.
In turn, an improving trade environment, as well as improved access to finance, will allow firms to raise their investment spending. According to the EEF, capital spending growth will rebound significantly to 2.4% in 2015 and 2.8% in 2016, from 1.3% in 2014. As a result, investment’s contribution to growth, which was strongly negative in 2013, is expected to be moderate through 2014, and then firm in 2015 and 2016.
However, the recovery in investment will probably be weaker than in previous recessions, due to the high levels of corporate debt, elevated real costs of borrowing for small- and medium-sized enterprises (SMEs) and still-high financial fragmentation, according to EY.
“Access to bank finance for SMEs will be crucial if the region is to foster a significant and sustained upturn in investment. The recent decision by the ECB to buy asset-backed securities should help develop this source of finance for smaller firms in the medium to longer term, but in the coming couple of years SMEs seem more likely to remain reliant on bank funding,” Otty said.
The EEF expects consumption to gain momentum and to be an important engine of growth over 2015 and 2016, nearly doubling the pace of growth seen in 2014.
Consumer confidence is recovering and the projected decline in the jobless rate is positive for consumption. Rising incomes and falling unemployment may also induce consumers to reduce their precautionary saving in favor of spending, according to EY.
A possible impetus to household spending may come from any rebound in consumer credit in response to the TLTRO program and easing in credit conditions, as suggested by the June ECB bank lending survey. And the survey also pointed to increased household demand for loans. Overall, these factors should contribute to a rise in consumption growth to 1.4% in 2015 and 1.5% in 2016 from just 0.8% this year.
“Despite fading constraints from the deep financial crisis, the recovery in the Eurozone remains fragile to adverse shocks. Deflation should be averted but clearly remains a risk, while geopolitical developments outside the Eurozone that pose a threat to the world recovery could also push the Eurozone back into recession. Policymakers will need to remain vigilant to these risks for some time yet. Moreover, where more can be done to boost competitiveness and growth prospects through reform efforts in individual countries, these opportunities should be taken as a matter of priority,” Rogers said.