Standard Life Investments

Weekly Economic Briefing

Europe

High ho-ho-hope

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After a stellar 2017 for the Eurozone economy, thoughts are naturally turning to the outlook for 2018 and beyond. Questions about the immediate future abound: can the currency union continue to grow strongly above potential? And if so, what will drive that growth? We recently upgraded our growth forecasts for the Eurozone economy to 2.2% in 2018 and 1.9% in 2019. The upgrade to 2018 growth reflects our view that business investment will take a more central role in the broad Eurozone growth mix as the wounds of the Eurozone crisis continue to heal and business optimism is bolstered. The global macroeconomic environment has been a boon for the Eurozone economy in 2017 and this forecast builds in an assumption that the climate remains favourable for firms and households. Gross fixed capital consumption already rose 4.25% in the year to Q3, with machinery, equipment and weapons systems growing 7.2% over the 12 month period. High levels of new orders and robust corporate sentiment should make 2018 a year that delivers stronger investment than since the crisis (see Chart 6).

On the up and up Follow the Leader?

Another major question for 2018 relates to ECB policy, with regards to a tapering of its asset purchase programme (APP) and the prospect for rate hikes. We know that the ECB Governing Council has committed to continuing the APP at a lower level of €30 billion per month until September 2018. However, debate remains about whether the programme will end in October or whether the ECB will extend at yet another lower level for a number of months after. We think that if the growth and inflation profiles for the economy play out as we expect, the APP can justifiably end in October without an additional tapering. However, should we see a marked worsening in growth and/or inflation, or excessive tightening in monetary & financial conditions, we think that Draghi’s comments following the last meeting provides clear optionality to extend purchases. We do not forecast interest rates rising until well after the APP ends; we do not expect a rate hike in 2018 and have only penciled in one repo rate hike by the end of 2019.

The biggest question marks for the Eurozone in 2017 were around political risk; will 2018 face the same level of political risk? The electoral calendar is meant to be a little lighter this year, with Italy the only major general election scheduled. However, the fragmentation of European politics in recent years has led to smaller and more potentially vulnerable coalitions, increasing the risk of snap elections and the political horse-trading that ensues. Italy presents a potential source of political risk because of the presence of two significant populist Eurosceptic parties, the 5 Star Movement and the Northern League. However, both have moderated their stances on Europe in recent months, with the former party declaring last week that the party is “pro-EU” and pushing for reforms that include more powers for the European Parliament. That said, political rhetoric – particularly from the 5 Star Movement – is prone to flux so we will monitor their approach carefully. Meanwhile, we expect the broader European integration agenda to gain some momentum in 2018, but we assume this process will be arduous and unlikely to see significant change in 2018 given divergences in views across core and periphery on risk sharing and fiscal unity (See Chart 7).

Stephanie Kelly, Political Economist, Standard Life Investments