Global Daily – Further downgrading European growth

by: Aline Schuiling , Nick Kounis

Euro Macro: Revising growth in 2018Q4-2019Q1 lower but improvement during this year – The latest reports about the eurozone economy and its biggest individual member states, have made us revise our forecasts for eurozone GDP growth for the end of 2018 and start of 2019 lower. Ongoing contraction in Germany’s industrial sector, disruptions to growth in France due to strikes and protests, a drop in the eurozone composite PMI to just above 51 in December, and ongoing declines in the global manufacturing PMI have all signalled ongoing weakness in economic activity in the eurozone. Indeed, we have roughly halved our forecasts for GDP growth in 2018Q4 and 2019Q1 from 0.3-0.4% qoq in each quarter, to round 0.2%. This modest level of growth is expected to be the combined result from ongoing negative contributions to growth from net exports and continued expansion of final domestic demand, largely because of a pick-up in consumption on the back of lower inflation.

We expect the economy to regain some traction, albeit only to around trend rates, during the course of this year. First of all, some one-off factors should fade. In particular, we assume that the French economy will return to growth in Q2 after being hit by the protests in Q4-Q1. Looking further ahead, we think that an improvement in the global economy and world trade will see eurozone exports gaining some momentum during the course of 2019. We expect policymakers to facilitate a modest recovery in world trade growth. The FOMC seems less fixed on further interest rate hikes, the ECB may keep interest rates on hold for even longer (see below), while China’s policymakers have stepped up stimulus. Having said all this (as noted in yesterday’s daily) we do not think that these policy shifts will be sufficient enough to foster a strong economic recovery. Meanwhile, eurozone domestic demand should continue to grow at a decent pace, although some strength probably will shift away from fixed investment (which will slow) towards private consumption and government spending. All in all, we expect growth to be around the trend rate of 0.3-0.4% qoq in 2019Q2-Q4.

Bringing all these changes together leaves our year average forecast for 2019 at 1.1% (from 1.4% previously), while our forecast for 2020 remains unchanged at 1.3%. This is below the current consensus forecast of 1.6% for this year and 1.5% for next year.

ECB View: Period of unchanged rates may last deeper into 2020 – Our current baseline scenario is that the ECB will keep interest rates unchanged until March 2020 and will hike its policy rates modestly by 20bp next year. This is later than the ECB is currently signalling (towards the end of 2019) so we expect the central bank to change its forward guidance in coming months to communicate that policy rates will likely remain on hold through 2019. The changes in our economic growth forecasts for the eurozone raise the risk that the ECB will keep interest rates on hold deeper into 2020. This is because lower economic growth will likely translate into an (even more) subdued outlook for core inflation. The current consensus of analysts recorded in a Bloomberg Survey last month, is that the ECB will hike by 25bp by the end of 2019 and by a cumulative 65bp by the end of 2020. However, financial markets have shifted closer to our current base case, with the first hike fully priced in only in March/April 2020. (Aline Schuiling & Nick Kounis)