EY Eurozone Forecast: March 2015

Cheap oil and support policy to drive the recovery

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Domestic healing supported by cheaper oil

  • After a year of tentative recovery in 2014, the Eurozone moves into 2015 aided by two important growth drivers – sharply lower oil prices and quantitative easing (QE). These factors will help GDP growth accelerate from 0.9% in 2014 to 1.5% this year and then 1.8% in 2016. But despite the improving near-term outlook, Eurozone growth will still be only 1.6% a year in 2017-19, as it is held down by a number of structural constraints.
  • Throughout 2014 there was gradual domestic healing in the Eurozone as consumers regained confidence and the unemployment rate stopped rising. This will be supported in 2015 by lower oil prices, which we estimate will boost real household income by 1%-1.5%, enabling consumer spending growth to accelerate from 0.9% in 2014 to 1.6% this year. But the degree of spare labor will hold back wage growth for some years yet, so we expect consumer spending growth to remain around 1.5% from 2016 onwards.

…ECB bond-buying will aid exports and investment …

  • But falling oil prices have heightened fears of deflation. Given the impact on energy bills, we now expect consumer prices to fall 0.2% in 2015, and then rise just 1.1% in 2016. But the ECB’s recent announcement of substantial sovereign bond purchases is expected to prevent a deflationary spiral and underpin medium-term inflation expectations at 2%.
  • QE will also weaken the euro further, but in light of weaker emerging market demand the pickup in export growth will be relatively muted – we forecast export growth of 4% in 2015 and 4.5% in 2016. Furthermore, in the longer term, export growth will be constrained by higher costs than elsewhere unless there are more structural reforms.
  • Stronger domestic and external demand, plus improving access to finance, should underpin business confidence and spur faster capital spending. Alongside a tentative recovery in housing markets and stabilizing public investment, this will help fixed investment grow by 0.5% in 2015 and 2.8% in 2016. However, with limits on the pace of domestic and external demand growth, investment is unlikely to accelerate much further over the medium term.

… but tight fiscal policy can be eased only gradually

  • Rising growth and lower borrowing costs will have a positive impact on public finances in the next few years. But with public debt above 90% of GDP in eight countries, and at 96% for the Eurozone overall, room for fiscal easing is limited. Nevertheless the period of emergency austerity is over, and we now expect government spending to contribute modestly to growth.
  • Threats to stability remain – principally from the prospect of difficult negotiations over Greece’s debt. But at least these discussions are taking place in an improving macroeconomic and financial environment in much of the rest of the Eurozone. The conflict in Ukraine will also continue to pose a risk to confidence but, with much lower global energy prices, one of the key transmission mechanisms of a spiraling conflict to the Eurozone looks to be less potent.