Carsten Brzeski's blog

Good is not good enough

Putting the Eurozone’s current upswing into perspective
With political risks melting away like snow in the sun, the Eurozone economy could become the positive growth surprise of the global economy. However, to ensure that this surprise is structural rather than simply short-lived, more effort will be needed.

What a difference two elections can make. While at the start of the year, political risks in the Eurozone were haunting financial markets and many observers, the elections in the Netherlands and France have shown the limits of anti-euro and anti-European populism. At least for now, as Italian elections next year might reignite fears about the euro. Under the surface of political risks, the Eurozone economy has gradually strengthened further. In fact, Tuesday’s GDP data should confirm that the Eurozone economy has grown faster than the economies of the US or the UK during the first quarter of this year; a period in which political risks and uncertainties were still considered to be high.

We expect GDP growth in the Eurozone to come in at just under 2% this year, which would be the second-strongest year in a decade. Contrary to earlier stages of the recovery, growth is no longer exclusively driven by a few (or only one) strong countries. The recovery is broadening across all Eurozone countries. While Germany is still – and even a bit surprisingly given the lack of structural reforms – going strongly, other countries which have rapidly recovered from deep crises are also contributing positively to a recovery; just think of Spain, Portugal, Ireland and the Netherlands. More generally, the Eurozone economy is clearly benefiting from low interest rates, a weak euro and low oil prices.

While the Eurozone should continue to enjoy supportive tailwinds and a cyclical recovery, to a large extent reflecting a catching up process, the upside to this recovery seems limited due to several structural factors: the ageing population is weighing on growth, the capital stock has not been growing rapidly, the amount of structural unemployment in the economy is still high and innovation has not been translating to stronger productivity growth.

All of this means that with fading political uncertainty and a continuing cyclical upswing, the ECB will have very little reason not to start thinking about a very gentle exit from its ultra-loose monetary policies. The risk of deflation, which stood at the start of the QE programme, has clearly disappeared. At the same time, however, the structural problems and weaknesses of the Eurozone will prevent the ECB from changing its monetary stance drastically. In fact, tapering will not mean tightening. Therefore, we expect the ECB to start a gradual process towards tapering as early as at the June meeting. This process could take several months and could consist of language tweaks, changes to the risk assessment and tasking technical committees before the official announcement of a reduction of the asset purchasing programme for 2018 would follow. Rate hikes will only follow towards or after the end of QE.