Global Daily – Eurozone stuck in the doldrums

by: Aline Schuiling , Han de Jong

Euro Macro: Eurozone grows at around half the trend rate – The first estimate for Q4 GDP growth in the eurozone was published today. The economy expanded by 0.2% qoq, which is the same rate as in Q3, and equal to around half the trend growth rate. No detailed data have been published yet at the eurozone aggregate level, but a few large individual countries have published detailed reports. Indeed, France (GDP growth 0.3% qoq in Q4, the same as in Q3) and Spain (GDP growth 0.7%, following 0.6% in Q3) each reported that growth in domestic demand slowed down significantly in Q4, with fixed investment in machinery and equipment particularly weak. This is in line with our view that the weakness in exports that started in the beginning of 2018 has had a negative impact on fixed investment. Moreover, in France as well as in Spain private consumption growth slowed, whereas government consumption growth picked up. Finally, net exports contributed modestly positively to growth in France (0.2pp in Q4, down from 0.3 in Q3), but improved significantly in Spain (contribution from -0.2pp to +0.3pp in Q4). Considering that quarterly net exports tend to be rather volatile in Spain, we think it is too soon to draw any strong conclusions about net exports in the eurozone on aggregate in Q4.

Besides France and Spain, Italy has also published a first estimate for Q4 GDP growth. GDP contracted by 0.2% qoq in, following -0.1% in Q3, implying that the country moved into recession according to the definition of two consecutive quarters of contraction. No breakdown of the contributions was published, but the written statement by Istat mentions that domestic demand (excluding inventory changes) contracted in Q4, whereas net exports were positive. The negative ending of 2018 for Italy’s economy means that the base for growth in 2019 is low and that the government will very likely miss its 2019 growth target of around 1.5% by a wide margin (we have pencilled in growth of merely 0.3% for 2019 as a whole).

Looking ahead, we think that growth in the eurozone on aggregate will remain close to the levels of 2018H2 in 2019Q1. Thereafter, it should pick up to close to the trend rate, as some one-off factors that have weighed on growth in 2018H2 and 2019Q1 will peter out. Moreover, there should be some improvement in global trade growth in the course of this year, and a pick-up in private consumption and government spending in the eurozone. (see our Eurozone Outlook 2019). (Aline Schuiling)

Euro Politics: Why the backstop is such a big issue – The UK parliament has sent PM Theresa May back to Brussels to renegotiate the UK’s withdrawal agreement from the EU. Specifically, the UK parliament wants an expiration date to, or the right to unilaterally withdraw from, the so-called ‘backstop’.

If the UK leaves the EU on the basis of some agreement, nothing will change immediately in the existing trade arrangements. Both sides will then take time to negotiate the future trade relationship. In principle this will be until the end of 2020, but can be extended to 2022 (the ‘transition period’). The backstop stipulates that as long as there is no long-term trade deal, the UK stays in the customs union and Northern Ireland will be subject to the rules of the single market. A majority in the UK parliament fears that the UK’s exit from the EU can effectively be blocked by the backstop is there is no end date to it, or no mechanism to withdraw unilaterally from it. The backstop may not apply if a trade deal is done and a satisfactory arrangement can be made for the border (which is almost 500 km long)

The backstop was agreed in December 2017. It must be seen as an effort to avoid a hard border between Northern Ireland and the Republic of Ireland. Republic of Ireland politicians correctly saw that the border issue could become very important in the withdrawal process and argued strongly in favour of avoiding a hard border very early on in the process. (Perhaps one could say they were way ahead of many UK politicians who only now appear to realise the possible consequences and want a time limit put on it.) The Irish politicians were successful. EU officials have always fully supported and are committed to the idea of no hard border.

Why ‘no hard border’ is so important to Ireland
Ireland was a colony of the UK for a very long time until the foundation of the Irish Free State in 1921. During the colonial times, the Irish were not always treated well. So the relationship between the two countries is somewhat ‘complex’. When Ireland got its independence, it was agreed that six of the eight counties of the province of Ulster would remain part of the UK. This part of the agreement of 1921 was obviously controversial and this ‘partition’ of Ireland gave rise to violence from the late 1960s until into the 1990s. The violence ended with the Good Friday peace agreement of 1998. Power sharing between Catholics and Protestants and the establishment of institutions for cross-border cooperation were key elements. The relationship between Northern Ireland and the Republic is a unique one. For example, people born and living in Northern Ireland can obtain a passport of the Republic.

The Good Friday agreement does not say much about the border except that the military installations, where heavily armed UK military checked in- and out-going traffic, should be removed. And they are, indeed, gone. The border is completely open. While the agreement does not explicitly say there cannot be border checks of any sort, the Irish government has interpreted the agreement in this way and people living in the area experience the current completely open border as a result of the Good Friday agreement. Many would see the imposition of a hard border as the peace process going into reverse. This is obviously seen as a dangerous and totally undesirable development.

The Irish government cannot agree to a time limit on the backstop
The two main political parties in Ireland, Fine Gael and Fianna Fáil essentially find their origin in opposing views of the independence agreement of 1921. Fine Gael was formed by the people who supported the deal. Fianna Fáil was formed by people who opposed the fact that the agreement with the UK government split up Ireland – the partitioning. The ideological differences between the two parties are small. The current government is a minority government of Fine Gael and a number of independents, but is supported by Fianna Fáil. Leo Varadkar is the ‘Taoiseach’, or Prime Minister. The relationship between the parties remains complex. After the last elections, neither party was able to form a majority government without the involvement of Sinn Féin, which neither party was willing to do.

One never knows what can happen in politics. It is possible that the UK agreeing a permanent customs union with the EU – of which there are now rumblings – could neutralise the need for a backstop. But in the absence of that, it seems to us that Irish politicians are not going to agree on a time limit for the backstop. Fine Gael would risk being seen as the party that would, for the second time in history, agree to a partitioning of Ireland. Irish politicians have the full support on this issue on the EU’s side of the negotiations. Chief negotiator Michel Barnier has called the backstop ‘part and parcel’ of the withdrawal agreement. Perhaps it remains to be seen how strong EU support for the Irish position is if putting an end date on the backstop appears the only way to avoid a hard Brexit. But for now, that support looks rock solid. Unless the UK changes its position on a customs union, we therefore believe Theresa May’s efforts to try and negotiate an end date to the backstop will fail. (Han de Jong)