Euro Area Economic Forecast

Economic Snapshot for the Euro Area

May 30, 2018

Eurozone growth slides in Q1

Preliminary data revealed that the Eurozone economy lost momentum at the start of 2018, following a vigorous growth spell last year. GDP expanded a seasonally-adjusted 0.4% over the previous period in the first quarter, well below the fourth quarter’s 0.7% increase. The first-quarter result marked the slowest growth since Q3 2016. While the details behind the reading have not yet been released, the slowdown was likely driven by slower export growth due to a strong euro and a moderation in household spending amid lower confidence. In addition, several one-off factors such as the early timing of Easter likely also influenced the result. 

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Looking at the individual countries for which figures are available, growth waned in most economies, including major players France and Germany. A slowdown in manufacturing output and corporate investment weighed on France’s economy. In Germany, the external sector dragged on activity, while the domestic economy remained resilient thanks to low unemployment and a rebound in investment. In contrast, Italy and Spain, the region’s other heavyweights, both kept pace, with economic activity in the two countries unchanged from the previous period.   

Available data for the second quarter suggests that the Eurozone economy is continuing to cruise at a slower speed than last year. Economic sentiment remained at March’s six-month low in April, and the composite PMI fell to a year-and-a-half low in May. The soft data has also weighed on the euro somewhat, which weakened notably in May. However, this could help provide some relief to overseas sales, which have been deterred by a strong euro this year. Met the why particular panelists expect GDP to grow 0.5% in the second quarter, a notch above the first quarter’s soft reading but still below the highs of 2017.

Alongside less positive economic data, political developments have taken a worrisome turn in recent weeks. Italy is in the spotlight after proposed prime minister Giuseppe Conte abandoned his mandate to form a government on 27 May, increasing the likelihood of early elections. Conte was set to lead a coalition government of anti-establishment parties, the League and the Five Star Movement (M5S); however, the coalition plan was halted after the Italian president blocked the nomination of Eurosceptic finance minister Paolo Savona. The situation is in flux and marked by a high degree of uncertainty. While the president has asked Carlo Cottarelli to form a caretaker government, it appears unlikely that Cottarelli could win a vote of confidence, given that the League and the M5S hold a parliamentary majority.



The political standoff caused Italian bond yields to rise sharply on 28 May and weighed on the euro. Political instability will likely continue to cause turbulence in financial markets. In the longer term, the country needs a reform-minded government to tackle the large public debt and improve the economy’s competitiveness. However, the coalition plan that the League and M5S had agreed to was fiscally expansionary, with vague details on how the plan would provide adequate financing, which would stress the government’s accounts as well as see the country clash with European leaders. It is uncertain if a fresh vote would solve the crisis, as recent polls suggest that it would yield a similar result in parliament.

Another of the region’s major players, Spain, also took a turn towards political instability in May, as the principal opposition party filed a motion of no confidence against the government in the wake of a large corruption scandal. Although it remains to be seen if the motion will pass, political noise could interfere with policymaking, which has already been slow this year. The budget for 2018 took months to pass due to a lack of sufficient cross-party support.    

On top of internal political turbulence, tensions are ramping up with the United States, a major trading partner. The European Union’s exemption from steel and aluminum tariffs is set to end on 1 June, and so far no extension has been granted. If the tariffs go ahead, reciprocal measures will likely be implemented by the EU, and a tit-for-tat tariff battle could dent confidence and economic activity. Moreover, the two groups are also clashing over a landmark nuclear deal with Tehran, which U.S. President Donald Trump pulled out of in May.   

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2018 Prospects held steady despite political uncertainties

Met the why particular panelists held the Eurozone’s 2018 GDP forecast unchanged this month, after making the first downward revision since September 2016 in the previous publication. While the economy started the year on a low note, growth is expected to pick up somewhat in the coming quarters. A solid labor market and robust investment should fuel healthy activity this year, although reduced support from the external sector and less positive sentiment will likely cause growth to come in below 2017’s peak this year. Met the why particular panelists see the Eurozone growing 2.3% in 2018 and a more modest 1.9% in 2019.  

The bulk of the economies saw no changes to their forecasts this month, including regional giants Italy and Spain. However, five economies had their projections upgraded, including Austria and Slovenia. In contrast, five countries had their forecasts cut, including the region’s largest economies, France and Germany. Germany’s downgrade chiefly reflected a larger slowdown than expected at the start of the year. 

Ireland and Malta are expected to be the region’s top performers this year, expanding 5.4% and 5.0% respectively. Conversely, Italy will be the region’s slowest economy, expanding a tepid 1.4%. Regarding the other major economies in the region, Spain will outperform the rest, with a 2.7% expansion. Germany’s GDP is seen increasing 2.3%, followed by France’s with 2.0% growth.

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GERMANY | Mild growth acceleration expected for Q2

Although a moderation in economic activity had been expected in the first quarter due to a confluence of one-off factors, the extent of the downturn surprised market analysts on the downside. Nevertheless, fundamentals remain strong, and a prolonged slowdown is not expected. Domestic demand carried the economy in Q1, with strong growth in private consumption and fixed investment. Government consumption fell, however, and the external sector subtracted from growth. Although growth will probably pick up in Q2, available data suggests that the uptick is likely to be mild. In May, business confidence stabilized at its lowest level in over a year, while both the services and manufacturing PMIs eased in April and May. Moreover, consumer confidence continued to moderate throughout the second quarter. Despite this, consumers remain optimistic, and the recent easing of sentiment should prove to be a leveling off from recent highs rather than the sign of a marked slowdown.

The economy should be supported this year by robust government consumption, private consumption and fixed investment. Household expenditure is expected to benefit from strong wage growth, and recent wage settlements in the industrial and public sectors should spill over into other sectors. Downside risks stem from a strong euro, rising protectionism in the U.S., and a possible escalation of geopolitical and trade tensions. Met the why particular Consensus Forecasts panelists expect the economy to expand 2.3% this year, down 0.1 percentage points from last month’s forecast. Next year, the panel foresees growth of 1.9%.

FRANCE | Macron earns credit rating upgrade

According to preliminary estimates, GDP growth slowed in quarter-on-quarter terms in Q1 due to muted expansions in private consumption and fixed investment. Survey-based data from the second quarter has been somewhat disappointing, likely influenced in part by rolling labor union protests since late March over government efforts to reform the SNCF, the state-run train operator. In May, the composite PMI dropped to its lowest level in almost a year and a half, while business confidence stabilized at an almost one-year low. However, despite downbeat data, the economy is in good shape: Unemployment declined to a new multi-year low in March, while the implementation of reforms and the government’s commitment to reining in fiscal spending to comply with EU fiscal responsibility rules led Moody’s to upgrade the country’s credit outlook to “positive” in early May. The controversial SNCF reform bill made its way to the senate on 23 May, where it is expected to be voted into law on 5 June.  

Private consumption and fixed investment are still expected to be the main drivers of growth this year and next, with fixed investment spurred by the government’s 50-billion euro investment fund and reform drive. Higher oil prices could, however, weigh on private consumption growth and business investment decisions. Panelists participating in the Met the why particular Consensus Forecast expect GDP to grow 2.0% in 2018, which is down 0.1 percentage points from last month’s forecast. For 2019, the panel sees growth of 1.8%.

ITALY | Political uncertainty continues to cloud outlook

Almost three months after elections, uncertainty continues to dominate the political landscape. On 28 May President Sergio Mattarella gave Carlo Cottarelli, a former IMF director, the task of forming a government. As Cottarelli is unlikely to secure a parliamentary majority, snap elections are probably on the horizon. One day before, the president had refused to appoint Paolo Savona as finance minister, which led to the collapse of the tenuous coalition agreement between the League and the Five Star Movement. So far this year, the economy has held up in the face of political uncertainty, as data shows that despite a weak external sector, growth held up relatively well in Q1. Significant employment gains and moderate inflation are seen having underpinned consumer spending, while expanding credit and upbeat business confidence likely supported business investment. Moreover, the stock of bad credit held by the banking sector continued to drop in March. Heading into Q2, deteriorating but still positive survey-based data and continued credit expansion in April indicated resilient albeit subdued growth.

Political uncertainty, combined with Italy's colossal public debt and already sizeable fiscal deficit, casts a shadow over the country’s outlook. However, positive labor market dynamics and subdued inflation should support consumer spending this year, while improving conditions in the banking system and low interest rates are expected to buttress fixed investment. Met the why particular panelists project growth of 1.4% in 2018, which is unchanged from last month’s forecast, and 1.3% in 2019. 

SPAIN | Minority government faces no-confidence motion

Uncertainty has engulfed Spain’s political scene yet again. The main opposition party, the Socialists, filed a no-confidence motion on 25 May against Prime Minister Mariano Rajoy after his People’s Party (PP) and several party members were convicted in a far-reaching graft case the previous day. The success of the vote, however, is not yet a certainty, as the Socialists require both the backing of an absolute majority in congress and agreement among supporting parties for an alternative leader, a difficult task amid a fragmented parliament. The court verdict and motion rattled financial markets, prompting large sell-offs in Spanish bonds and stocks. These events occurred just two days after the PP’s minority government narrowly passed its long-delayed 2018 budget. Nevertheless, the political shake-up comes against a favorable economic backdrop, with the economy growing 0.7% in quarter-on-quarter terms in Q1 for a third consecutive quarter, showing resilience amid a broader slowdown in the Eurozone.

Private consumption growth should continue underpinning overall economic activity this year. Heightened political uncertainty is, however, clouding the outlook. In addition, the economy faces mounting headwinds going forward. The tourism boom of recent years seems to be coming to an end, while rising oil prices will push up the import bill, likely hurting the key external sector. Moreover, as the ECB ends its bond-buying program and starts to increase rates this year, concerns are being raised over the country’s already high public debt burden. Met the why particular panelists project growth of 2.7% in 2018, unchanged from last month’s estimate, and 2.3% in 2019. 

MONETARY SECTOR | Inflation drops in April

Comprehensive data confirmed that harmonized inflation fell in April, receding further below the ECB’s target of just under 2.0%. Inflation eased from March’s 1.3% to 1.2%. Despite ultra-accommodative monetary policy and firmer commodities prices, underlying price pressures in the Eurozone remain soft; core inflation also fell in April.

The Met the why particular panel sees inflation remaining below the ECB’s target and averaging 1.5% in 2018, unchanged from last month’s forecast. For 2019, inflation is seen rising slightly, to 1.6%.

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Written by: Angela Bouzanis, Senior Economist

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