Commission forecasts paint a less than optimistic picture for eurozone outlook

The European Commission has this morning released its Autumn 2014 Economic forecasts. While these forecasts can often be quite mundane owing to the very managed message they are trying to send, this set look to be a bit different (see here for our take on Winter 2014 and Autumn 2013). Maybe unsurprisingly the tone to more sceptical, critical and possibly realistic. Below outline some interesting themes.

Another downward growth revision
Once again growth for the Eurozone has been revised down. The previous forecast saw 1.2% and 1.8% growth in 2014 and 2015 respectively. The new forecast predicts 0.8% and 1.1% respectively, quite a significant downward revision, especially since growth next year is now expected to be below the original forecast for this year. The initial blame (in the press release) for this revision seems to be laid at the feet of “increasing geopolitical risks and less favourable world economic prospects”. However, that raises the question of why it is seen as enduring up to 2016. In the report itself the assessment is thankfully more candid highlighting “incomplete internal and external adjustment” and “low productivity gains”.

More realism about the labour market
There is a wider acceptance in these forecasts that unemployment will remain elevated for some time and that differences in labour market performance will persist. That said, at the moment any real prospect on employment growth in the Eurozone seems optimistic.

Bad news in nearly all the large economies
France and Germany’s growth prospects for this year have been revised downwards to 0.3% and 1.3%, from 1% and 1.8% respectively. Italy is expected to contract by 0.4% this year and only grow 0.6% and 1.1% in 2015 and 2016 respectively. Given that these three countries account for nearly 60% of Eurozone GDP this suggests a very poor outlook for the Eurozone with growth risks tilted to the downside. In general, the core vs. periphery split is less clear in this report, at least in growth terms as many countries are now acting as a drag on the Eurozone economy for a number of reasons.

Significant and increasing reliance on domestic over external demand
Early on in the crisis there was a clear focus on facilitating export led recoveries, often in the German model. However, over the past 12 – 18 months this has shifted, possibly driven by global economic weakness, and these forecasts finalise the shift. The Commission itself says,  “Net exports are likely to contribute only marginally to GDP growth over the forecast horizon”. Spain is a prime example of this, see here for a longer discussion of the issue.

While finding a balance between the two is important (we cannot have 18 Germanys in the Eurozone) the shift may have been too stark. Let’s not forget that there is still a huge amount of public and private debt (both household and corporate) in the Eurozone, especially in problem countries. This will limit potential domestic demand growth. So while the flows are shifting in a way which should see an uptick in domestic demand, we should not forget that the huge stock of debt may provide a ceiling on this as a driver of growth.

Low inflation is here to stay
The Commission has also downgraded its inflation forecast with CPI expected to be 0.8% in 2015 compared to previous forecast of 1.2%, while it is only expected to be 1.5% in 2016. The forecast for 2015 is below the ECB’s of 1.1% but the 2016 is above the ECB’s which is 1.4%. Interestingly, the Commission continues to make the case that “low, or negative, inflation rates as part of [some countries] inevitable adjustment process”. This is an argument which has been absent all recent ECB press conferences. In terms of deflation, the Commission sides with the ECB, saying the risks of outright deflation remain low.

We’ll update the blog throughout the day as we pour over the 185 page report. But for now, we’ll leave you with a thought from Commissioner Jyrki Katainen in the press conference, when asked how much the forecasts can be trusted given a history of being incorrect he simply responded, “Nobody knows”. Quite.

The European Commission's new economic forecasts: Fragile recovery continues, but problems remain

The latest Commission economic forecasts are out and the theme of a broad but still fragile recovery (combined with some gentle self-congratulations on the success of the current approach) has been continued. For the most part the forecasts are not hugely different from the Autumn 2013 ones, which we covered here.

We won’t do a country by country run down again, since little has changed. But we pick up on a few general themes below.

Inflation forecast cut
A metric which everyone is watching at the moment is inflation. As we have discussed before, March has been pegged as a key meeting for the ECB and is expected to be a defining choice over whether the bank takes more action to tackle inflation. The EC has cut its forecast for inflation from 1.5% to 1.1% for this year while last year’s has been revised to 1.3% from 1.5%. Despite the language being quite strong on inflation remaining low and subdued, these forecasts aren’t far from the ECB’s own and are unlikely to push them one way or another when it comes to taking further action. The graph also highlights that the view of core inflation (without energy or food prices) been on a slow decline for some time but is expected to melt upwards over the coming years. Again this fits with current ECB thinking rather than bucking against it.

Spain and Italy – diverging forecasts, but plenty of common problems
One of the more surprising points is that Spain has got the most substantial upgrade of all the big eurozone countries – with its 2014 growth forecast raised from +0.5% to +1%. At the same time Italy is the only big eurozone country whose growth forecast for this year has been revised downwards – from +0.7% to +0.6%. Similarly, on the unemployment side (while Spain remains in a much worse position) the forecast has improved somewhat for Spain and worsened for Italy. In any case, both continue to struggle with their large debt loads (more below), although new Italian Prime Minister Matteo Renzi might take the less than optimistic forecast as an important reminder of the reforms he needs to pursue, not unlike the ones Spain has undertaken…

Debt remains a problem in the eurozone
By 2015, seven eurozone countries are forecast to have public debt levels above 100% of GDP – Belgium, Ireland, Cyprus, Greece, Spain, Italy and Portugal. As the report warns, this debt overhang could become a drag on medium term growth, particularly when combined with other factors such as the knock on effects of years of depressed investment, high unemployment and falling productivity.

Borrowing costs for SMEs have come down but remain divergent in eurozone
As the graph highlights, there has been some improvement over the past few months. That said, borrowing costs for firms in France and Germany remain substantially below those in the periphery countries. Given the importance for SMEs, particularly in Italy and Spain, it is difficult to see a strong pick-up in economic activity or employment until SMEs can fund themselves effectively at reasonable rates.

Transition from export driven growth to a more balanced recovery
The EC suggests that the recovery is and will become more broadly balanced. As we have warned, particularly with regards to Portugal, becoming overly reliant on exports can be dangerous as it’s not clear that there will be sufficient demand to pull the economy out of its slump. That said, the Commission doesn’t entirely provide convincing ground for the significant turnaround in domestic demand and investment which is expected. With firms and households still weighed down by significant amounts of debt in much of the periphery and borrowing costs remaining high, it’s not yet clear that this can take place as quickly as is hoped. As the graph below shows, the turnaround needed is substantial.

Labour market continues to lag behind
Even if you buy into other parts of the recovery, it’s clear it hasn’t yet come close to improving the serious unemployment problem in much of Europe. Divergence is also expected to remain with many of the peripheral countries having incredibly high unemployment for the foreseeable future (well beyond the timeline of these forecasts).

And finally, seriously, what’s wrong with Finland? This data marks another bad day for the Finnish government, with the Finnish economy forecast to grow by only 0.2% this year, the slowest level behind Cyprus (-4.8%) and Slovenia (-0.1%), both embroiled in the eurozone crisis.