Eurozone real GDP growth has remained anaemic in 2015, slowing from 0.5% quarter-on-quarter in Q1 to 0.4% in Q2 and 0.3% in Q3 (respectively 1.3%, 1.6% and 1.6% year-on-year). However, deflation risks have diminished thanks to the depreciation of the euro since the first three months of 2015 and the eventual adoption of QE policies by the ECB, starting in March. I forecast 1.5% growth for the Eurozone in 2016.
For most of 2015 economic activity has been weaker and inflation lower than the authorities at the ECB had hoped, with the ECB revising down its forecasts and President Mario Draghi announcing a modest extension of the QE programme on 3 December.
Although the amounts purchased each month by the central bank remain unchanged at €60bn, the range of assets to be purchased was widened to include provincial or regional authority debt instruments, and the date for ending the asset purchases was moved out 6 months until “the end of March 2017, or beyond, if necessary”.
The principal payments on maturing holdings would henceforth be re-invested and the interest rate on the ECB’s deposit rate facility was lowered by an additional 10 basis points to minus 0.30%. As explained in past issues of this publication, the QE programme continues to be less stimulating to markets and the broader Euro-area economy than it should be due to basic design flaws.
In the final quarter economic activity may have improved somewhat, as suggested by the small rise in the composite Purchasing Managers’ Index (PMI) to 53.9 in October and 54.2 in November. Across the major economies of the Euro-area the PMIs are generally above the 50 line that separates expansion from contraction, with composite indices for Germany at 55.2 in November, 54.3 in Italy, and 56.2 in Spain.
Only France is significantly weaker at 51.0 in November. The German Ifo index of business conditions recorded its highest level for the year (109.0) in November, and has been on a rising trend since October 2014.
However, the labour market in Europe continues to make only very slow progress with unemployment falling from a peak of 12.1% in June 2013 to 10.8% in September 2015, contrasting sharply with the steep declines seen in the US and the UK over the past five years.
One factor which perhaps should have made a greater contribution to Euro-area growth was the depreciation of the euro from US$1.25 to 1.05 by mid-March, subsequently fluctuating in the range 1.15-1.05 for the rest of the year.
Exports from the euro-area have only picked up since mid-2015, although the growth rate in September was still only 6.3% year-on-year. The main explanation is that without volume growth abroad, price changes alone will do little to boost demand from Europe.
Consequently, eurozone exports, in line with the sluggish performance of global trade in recent years, were essentially static between 2012 and mid-2015. Meantime the current account has moved to a surplus of 2.9% of GDP, mainly due to weak imports.
In addition to these cyclical problems, the repair of balance sheets in the eurozone is proving slow, although given the fiscal squeeze imposed by the authorities this is not surprising. Only in Spain, Ireland and one or two sectors elsewhere such as the German and Italian financial sectors has indebtedness declined relative to GDP.
Despite the ECB’s QE measures, the Euro-area is still dangerously close to deflation. In January 2015 the headline CPI had fallen to -0.6% year-on-year, and in November it was still only +0.14%, while the GDP deflator was 1.3% in Q3. Importantly the rate of growth of money and credit in the eurozone has been improving, but since it takes two years for the full effects of faster money growth to feed through to inflation, it will be another year before positive inflation rates can be assured.
Meantime the weakness of commodity prices is having a temporary downward effect on reported inflation. The ECB must therefore encourage faster growth of broad money and credit than it has allowed so far. I forecast the inflation rate of the eurozone as a whole will be 1.0% in 2016 – still well below target.