EY Eurozone Forecast: June 2014

Economic recovery is gradually building momentum

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The Eurozone’s growth prospects are still improving …

  • With some peripheral countries picking up speed as their competitiveness improves, the Eurozone is expected to continue to recover, despite sluggish growth in some core countries. Exports are strengthening and a slow pickup in domestic demand will drive a return to modest investment growth.
  • After 2 years of GDP decline, we forecast growth of 1.1% for the Eurozone as a whole this year — assuming that the economic effects of the crisis in Ukraine are contained. We expect to see this followed by expansion of 1.5% in 2015, and a slightly faster pace in 2016–18.

… but divergence between member states persists

  • The problem of divergence within the Eurozone — and not just between the core and periphery — looks set to remain. The outlook is still favorable for Germany, Ireland, Spain, Portugal and the Baltics (with Lithuania's accession to the Eurozone now confirmed for January 2015).
  • However, countries that have been slow to respond to the need for change — such as France, Italy, Belgium and the Netherlands — continue to lose competitiveness and face sluggish growth both this year and next.

Action to avert deflation is likely …

  • The threat of deflation is mounting. Inflation in the Eurozone was just 0.5% in May and the growth of money supply is still weak and slowing in much of the region. Deflation, or even a period of very low inflation, would add to the problems of sluggish growth by raising real levels of debt and by delaying spending and investment decisions.
  • So far, the ECB has appeared relaxed about the threat of deflation. But with inflation so far below its target of 2%, in early June the ECB cut its main policy rate to just 0.15%. It also set the deposit rate at -0.1%, thereby charging banks for depositing money at the central bank, in order to encourage them to lend to businesses and consumers.
  • But the change in rates is small and will only influence decisions at the margin. And there is still little sign of unconventional action, such as quantitative easing. We still think that more aggressive efforts to stimulate price growth and faster economic growth would be much easier to reverse in the future than a slide into deflation and more deleveraging.
  • At the same time, consumers and firms continue to face tight credit conditions in most countries, as banks try to repair their finances ahead of the findings of the ECB’s asset quality review, due in October. Consumer demand will also be restrained by ongoing high unemployment, which is seen falling only very slowly from the current level of just below 12%.

… and would help to weaken the euro, boosting exports

  • Contrary to expectations, the euro has strengthened in recent months. But with Eurozone monetary policy having been eased again in June (with the possibility of further stimulus measures in the coming months) and the US now moving toward tighter policy, the euro should start to weaken later this year and in 2015. This would in turn give a further boost to exports and help to support growth.