Eurozone is slowly picking up the pace

The risk of Eurozone breakup has been averted and we expect a slow growth from mid-2013. It is likely that 2013 will be a second consecutive year of mild contraction, with GDP forecast to fall by 0.5%. Growth will average only 1.4% a year in 2014-17, compared to the 2.3% average in the 10 years preceding the global financial crisis.

A further rise in unemployment in the short term, and only a slow decline from 2014, is likely to be another impediment to growth. Unemployment in the Eurozone overall reached a record high of 11.7% in December 2012.

The challenges to Eurozone growth identified in our previous forecasts persist and will hold back the pace of the recovery. Recent political developments in Italy, Spain and some smaller Eurozone countries may add to these challenges.

The improvement in confidence in the real economy has so far been less pronounced than the gains in financial markets. However, we believe that confidence will improve further over the course of the year. This will give businesses that have been hoarding cash an incentive to invest and hire additional workers. An improving economic backdrop should also, at the margin, increase the banks’ willingness to lend to companies.

Consumers’ willingness to make new purchases will be hampered by further increases in unemployment in 2013. Ongoing fiscal tightening also has a negative impact on household spending power. However, as the Eurozone economy stabilizes and then recovers, consumer spending is expected to start growing again in 2014.

Fiscal policy adjustment can be particularly complex in the aftermath of financial crises, given the need for supportive actions to revive growth. Consequently, Eurozone fiscal adjustment should rely not just on improvements in the primary balance, but also on steps to boost potential growth.

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