Structural issues dampen Eurozone GDP growth

Focus: Deescalation in trade conflict, Europe's growth nevertheless weak

Settlement of trade disputes within reach?

The stock and bond markets seem to be increasingly optimistic that one day the specter of trade conflicts will come to an end. China and the United States have agreed in recent weeks to lift tariffs. This is to take place at different stages, but what is still missing is a concrete timetable. It seems that both sides still have to agree on how much of the total tariffs should be lifted.

The extent of the cancelled tariffs should be the same on both sides. It is apparently planned that China and the US, as part of a first partial agreement (Phase 1), will withdraw part of the tariffs introduced at the same time. An essential part of this agreement will be Chinese purchases of American agricultural products and regulations for the protection of intellectual property. An agreement to this effect should have been ratified at a summit in Chile on November 17, but the summit was cancelled. According to media reports, US President Trump seems to be under time pressure, as bankruptcies among American farmers have risen by 24% over the last 12 months and the agricultural industry is demanding better market access and an agreement with China. The partial agreement should be signed by US President Donald Trump and Chinese President Xi Jinping at a location to be named in the coming weeks.

Wednesday next week (November 11) is the end of the 180-day deadline Donald Trump has set for his decision on sanctions against the European automotive industry. In May, he threatened to impose punitive tariffs of up to 25% on imports of European cars. The pressure from the US is growing, however, as German carmakers (BMW, Daimler, VW) provide jobs with their production facilities and also safeguard jobs in the US supply industry. In order to increase local added value, the US is apparently demanding investment commitments from German carmakers. It will be exciting to see whether Trump will again postpone the decision on tariffs next week or whether an agreement can soon be reached.

In particular, the trade conflict between the US and China has thrown a lot of sand in the works and dampened global trade and economic growth globally. Resolution of the conflicts in the foreseeable future would improve the mood in the economy, and the signing of the Phase 1 agreement would be an important step towards more confidence in that direction.

Structural issues dampen Eurozone GDP growth

On November 7, the European Commission published its autumn economic forecasts. The new outlook is clearly more pessimistic compared to the spring and the interim summer forecasts. Expected GDP growth of 1.1% in 2019 and 1.2% in 2020 (summer forecast: 1.2% in 2019 and 1.4% in 2020) is in line with our own forecasts. The expected downward adjustment was motivated by the continuing weakness of the manufacturing sector and aggravating uncertainties, which also weighed on international trade and could not be sufficiently offset in the short term by domestic demand.

While some of the risks and uncertainties (e.g. trade conflict between the US and China, prospects of hard Brexit) have considerably eased since the forecast was prepared, other factors still persist. These are i) a global economic slowdown caused by cyclical factors (which, however, seem to be coming to an end), ii) disruptions in car production (primarily in Germany, but also in other countries) and iii) geopolitical tensions, which suppress Eurozone growth in the short to medium term. In the longer run, structural shifts, such as declining trend in productivity, disruption of cross-border supply chains and ageing populations are expected to keep growth rates at a lower than pre-crisis level.

The inflation forecast for 2019 remained unchanged at 1.2%, while the inflation expectation for 2020 was revised down by 0.1% to 1.2%, compared to the summer forecast. This adjustment reflects ongoing lower oil prices and an only limited increase in core inflation, as wage adjustments are not fully passed through to the price level.

The EC expects Italy's public debt ratio to rise to 136.2% of GDP by year-end 2019. This is the legacy of the previous spendthrift populist government. At best, Italy can now hope to stabilize this debt level going forward. Due to structural issues, historically, Italy was never able to lower its public debt ratio sustainably. The scenario with the highest probability of success to lower Italy's debt ratio would be significantly accelerating inflation accompanied by the central bank keeping rates at low levels. However, especially for Italy, the outlook for inflation remains rather bleak (headline inflation in October stood at +0.2% y/y for Italy).

We expect the negative trends in manufacturing and trade to be rather temporary, and they should gradually fade since the settlement of the trade dispute seems to be within reach. We thus currently expect no recession, but rather a gradual slow acceleration of growth in the forecast horizon.

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