The FINANCIAL -- Although the second half of 2014 saw a continued slow pace of recovery and a revival of fears about the eurozone’s long-term future in the final months of 2014, GDP growth is expected to pick up from 0.8% in 2014 to 1.2% in 2015, and then 1.6% a year in 2016-18 according to the December 2014 issue of the EY Eurozone Forecast (EEF). The lagged effect of a weakening euro, easing fiscal austerity, lower oil prices and more certainty in the banking sector will combine to support the gradually strengthening eurozone recovery.
The eurozone will enjoy stronger export demand in 2015 — accelerating from 3.4% in 2014 to 3.7% in 2015 and then about 4% on average in 2016-18 — as the US and UK recoveries continue and a weaker euro offers relief to less competitive economies in the euro area. Furthermore, with the European Central Bank (ECB) asset quality review (AQR) helping to restore confidence in the banking sector, together with complementary measures from the ECB to boost liquidity, rising business confidence should be met with more readily available finance from 2015 onwards.
Despite the prospect of stronger growth in 2015, the legacy of the crisis means that the recovery will be slower than in previous rebounds. Households, businesses and governments in almost all countries will need to restrain spending growth in order to reduce debt levels. The pace of eurozone growth in 2016-18 will be more than half a percentage point slower than in the decade up to 2007, when GDP growth averaged 2.3% a year.
More worryingly, policy-makers have much-diminished weaponry to tackle any further shocks. With eight eurozone Member States’ public debt above 90% of GDP and six of these above 100%, governments have minimal room for fiscal stimulus. And in the event that inflation fails to pick up as fast as anticipated in the coming years, it is unclear whether a large-scale sovereign bond purchase program would be as powerful as it might have been a year or two ago, according to EY.
“Greater certainty in the banking sector, a weaker euro and falling energy costs are all supportive factors for a better economic outlook in the eurozone in 2015 than has been the case for some years. But it will be some time before wage growth rebounds to ‘normal’ rates, while high debt stocks mean governments need to exercise ongoing spending restraint. Both will constrain the rate of growth in the years to come,” Tom Rogers, Senior Economic Adviser to the EY Eurozone Forecast said.
“Even given divergences among countries, we think that 2015 holds a lot of promise for the eurozone as a whole. The effects of a weakening euro should be more substantial next year and exports should rise as a result. Despite this positive sentiment, the news of strong growth in some of the periphery is undercut by very high unemployment — a main concern for the eurozone and a problem that will not disappear overnight,” Mark Otty, EY’s Area Managing Partner for Europe, Middle East, India and Africa, said.
Investment set to recover as banks’ fears ease
With financing more readily available and demand conditions improving steadily, total fixed eurozone investment growth is estimated to pick up from zero in 2014 to 0.9% in 2015 and 2.7% in 2016, before settling around 2.5% thereafter. Moreover, with the ECB also aiming to reinvigorate the market for asset-backed securities — enabling banks to sell on loans and make further room for lending on their balance sheets — there is potential for an upside scenario.
It is also worth considering the potential for an upside risk from inward foreign direct investment (FDI). Some countries, Spain and Ireland in particular, have already benefited substantially from increased FDI inflows in recent years, thanks to much improved cost competitiveness and business environments. A depreciating euro should make inward FDI more attractive to firms outside the eurozone, as would reform efforts to boost underlying growth, according to EY.
Households buoyed by cheaper energy and a recovering labor market
After 15 consecutive quarters of oil prices above US$100 a barrel, consumers are experiencing an unexpected windfall as a range of supply and demand-side factors have pushed the oil price down to below US$80 a barrel. This factor alone should boost real household incomes by at least 0.3 percentage points in 2015 compared with our September forecast.
Furthermore, as exports continue to rebound and business investment gathers pace, the labor market will continue to heal, building on the progress made in 2014. That said, as public sector payrolls are rationalized further in a number of countries, overall employment is likely to grow only gradually, at around 0.4% a year through the forecast period. Moreover, with labor force participation recovering thanks to a combination of improved job prospects and reform efforts the unemployment rate will only fall modestly — from 11.5% in October 2014 to just over 11% by the end of 2016 and about 10.5% by the end of 2018.
Taking these supports to household income into account, EY expects the pace of consumer spending growth to pick up from 0.7% in 2014 to 1.3% in 2015. However, there is likely to be only minimal acceleration thereafter, to 1.4% annually in 2016-18, according to EY.
“Several eurozone governments are beginning to ease austerity programs, which should help domestic demand to grow. The sharp fall in world oil prices also will be welcome news to both households and businesses. On the other side, a slower growth in Asia-Pacific and China, key destinations for many eurozone investments and exports, as well as the very weak growth in France and contraction in Italy, are among factors which continue to make the eurozone vulnerable,” Otty said.
“After a long and difficult eurozone recession, we have seen a welcome improvement in business activity and confidence in recent quarters. Looking ahead, growth will pick up a little pace in 2015, and accelerate further in subsequent years. But if the eurozone is to avert future crises, the hard work to secure financial stability and economic prosperity needs to continue – in particular via improving the environment for investment and job creation in a number of economies,” Rogers said.