EY Eurozone Forecast: December 2013
Emerging from recession Eurozone will start growing in 2014
We think that both Latvia and Lithuania are well placed to adapt to Eurozone membership.
- Latvia will become the Eurozone’s 18th member on 1 January 2014 and we expect it to be followed in 2015 by Lithuania.
- Joining the Eurozone remains an attractive prospect for eastern European economies, because many already send a large chunk of their exports to the single currency area, so membership removes the exchange rate risk. There is also a perception that they are more likely to attract foreign direct investment as the cost of doing business with other Eurozone countries would fall.
- The loss of control over monetary policy in joining a currency area is a potential risk to small and open economies. However, taking into account earlier substantial internal devaluation and structural reforms, we think that both Latvia and Lithuania are well placed to adapt to Eurozone membership.
The Eurozone continues along the road to recovery …
- Ahead of Latvia’s accession, the Eurozone is on course for recovery, having achieved a second successive quarter of expansion in Q3 2013.
- After falling by an expected 0.5% in 2013 as a whole, we forecast Eurozone GDP will grow by 0.9% in 2014 and then by about 1.6% a year in 2015-17.
… and now looks less vulnerable to external shocks
- The resilience of financial markets in the face of political turmoil in Italy and fiscal issues in the US has been a pleasant surprise. This reflects faith in the European Central Bank (ECB) as a backstop for Eurozone bond markets and greater confidence in the outlook now that the economy has returned to growth.
- But this resilience cannot be taken for granted. The next big test is the ECB’s asset quality review and the subsequent restructuring of the banking sector. Policy-makers must ensure that – at the very minimum – the relatively modest expectations of the markets are met so as not to threaten the current stability of the region.
- The ECB will also have a key role to play in 2014 in setting policy to counter any tightening in credit conditions imported from the US once the Federal Reserve starts tapering. The surprise rate cut in November is unlikely to be enough to head off concerns about possible deflation.