Stockholm (Ekonamik) – The balance of risk to the eurozone’s economic outlook has deteriorated due to a slowdown in growth and concerns about increased protectionism, a broader global slowdown and market volatility, and fears of continuing trade wars, it emerged during the ECB’s first policy meeting of the year last week.
With downward revisions to global and eurozone growth forecasts and even some fears of a looming recession, eurozone interest rates are likely to remain constant through the summer, despite the ECB ending its €2.6 trillion crisis-era asset purchase buffer in December. Until then, the ECB will continue to use its forward guidance on interest rates to inform and influence the decisions of economic agents. Given present economic conditions and the ECB’s goal of “convergence of inflation to levels that are below, but close to, 2% over the medium term” among eurozone countries, markets have understood this to mean a hike is likely to occur in mid-2020.
These market fears are echoed in recent data releases. A Eurostat preliminary flash update for Q4 2018 put GDP quarter-on-quarter growth in the eurozone up a mere 0.2% (+1.2% respective to Q4 2017), while the ECB’s own Survey of Professional Forecasters pointed to sharply lower growth and inflation: its Q1 2019 survey put growth at 1.5% for 2019, well below the previous projection of 1.8%. Inflation is also expected to dip to 1.5% and projected to rise to 1.8% only in the longer term, suggesting that confidence in the ECB’s ability to reach its target of 2% is ebbing.
Of the four largest eurozone economies, the German economy slowed to 1.5% growth in 2018 (following an expansion of 2.2% in 2017) and has been cautiously forecast to grow by only 1.0% in 2019. Quarter-on-quarter growth turned negative in the third quarter of 2018 and, with official figures yet to be published, may have been close to zero in the final quarter of the year, although jobs growth remains strong.
Italy, for its part, has officially fallen back into recession for the first time since 2013, according to data published by the Italian National Institute of Statistics (ISTAT). The third largest economy in the Eurozone slid into recession in the last half of 2018, shrinking by 0.2% of GDP in fourth quarter after already contracting by 0.1% in the third quarter. The Bank of Italy cut its 2019 economic growth forecast to 0.6% from 1% last month.
The French economy, however, grew by 0.3% in Q4 2018, contributing to an annual growth of 1.5%, and a forecast of steady growth despite strikes and President Emmanuel Macron’s concessions to the gilets jaunes. And Spain became the strongest performer of the four big euro economies, with GDP growth of 0.7% in Q4 2018, up from 0.6% in Q3, and GDP for 2018 at 2.4%.
“We remain committed to maintaining interest rates very low, which is good for the economy. Progressively we are withdrawing monetary stimulus… but it is very progressive and depends on improvement in the economy. We’ll take the time it takes,” French central bank chief François Villeroy de Galhau, widely seen as the leading candidate to take over from ECB chief Mario Draghi in November, said on French television last week.
Bond Markets, Without a Net
A combination of slow growth, low inflation and low interest rates investors left the uncertainty of stocks in favour of the safety of bonds and sought yields in emerging markets, according to Bank of America Merrill Lynch. American and European stocks experienced outflow of US$15.2 billion and US$3.7 billion, respectively. Most of this cash seems to have ended up in bonds, which experienced inflows of US$9.4 billion, of which half went to investment-grade bonds. The remaining US$ 5.6 billion appears to have gone into Japanese and emerging market equities.
In secondary sovereign bond markets, Germany, France and Italy enjoyed their best January in three years, with governments’ borrowing costs at their lowest in many months. The solid start for bond markets in 2019 is unsurprising given the weakening forecasts for economic growth, and the ECB’s support for the markets through the reinvestment of the proceeds from maturing bonds it holds, even if it has stopped buying new assets.
Germany’s 10-Year Bund yield fell 5 bps in the last week of January on deepening growth worries, flattening the curve and sticking the yield around 0.17%. French 10-Year bond yields were down 10 bps in January and were set for their biggest monthly drop in eight months. Spanish 10-Year bond yields slid 16 bps, putting Spanish bonds on track for their best month since last March, and new long-dated bond sales from Spain met with record demand. The fall in yields is still surprising, though, because January was heavy with new debt supply from European governments, which usually tends to raise borrowing costs.
Italy’s borrowing costs, meanwhile, rose to their highest level in three weeks earlier this week amid heightened concerns about the country’s recession and deteriorating economic outlook. A sell-off in Italian bonds with yields across the curve rising up to 8 bps contrasted with the relative stability in broader eurozone bond markets.
Meanwhile, following some discussion in the minutes of the ECB meeting, speculation is rife that the ECB could launch a new round of cheap multi-year loans to banks. The policy tool, known in ECB-speak as Targeted long term refinancing operations (TLTROs) would be used to prop up the weaker southern European countries and shore up confidence in the financial sector. However, as the figures suggest, the malaise is not limited to the European periphery.
The question many will be asking themselves is whether the slowdown is temporary, or whether it is persistent, widespread and intense enough to lead to a recession. If the trend of bad news is confirmed, amid the wider global slowdown, political uncertainty and continuing trade disputes, a eurozone recession is certainly possible by the end of the year. The question then becomes what policymakers can do to counter it. The eurozone has developed better crisis-management tools and a stronger financial sector since the recessions of 2008 and 2011, suggesting that a recession this year might be less severe.
It still, however, lacks a common fiscal policy. This remains a fundamental risk in a year that could also prove politically risky to a European Union still wrestling with the possibility of a ‘Hard Brexit’ and a likely increased Eurosceptic populist presence in the European parliament following the European Parliament elections in May. More Eurosceptics are also expected to ascend to the European Council, which will nominate Commissioners to the European Commission when EC President Jean-Claude Juncker steps down in November.
That kind of influence across Europe’s institutions, in turn, could undermine the EU’s ability to manage day-to-day affairs and its message to the public and investors, and thus its ability to address a recession effectively. Consensus could be harder to build on key policy issues, and internal disagreements could also hamper the ability to react to crises, such as e.g. an economic meltdown in Italy. The eurozone slowdown may only be the first portent of a difficult year ahead.
Image: DXR, Wikimedia Commons