Eurozone 4Q17: Strong economics, shaky politics - ING

The Eurozone economy keeps on surprising to the upside, with growth now firmly hovering above the 2% threshold, points out Peter Vanden Houte, Chief Eurozone Economist at ING.

Key Quotes

“Political risks have not disappeared and the outcome of the German elections has all but squashed hopes of a further integration push that might make the Eurozone construction more solid. As inflation continues to undershoot the ECB is likely to continue its QE program for longer than expected, albeit with much lower monthly purchase amounts. A first rate hike is not to be expected before 2019.”

“Pundits have been revising upwards their growth prospects for the Eurozone economy throughout the year, as economic indicators have continued to surprise to the upside. Indeed, where at the beginning of the year a 2% growth rate looked out of reach, we will now likely be above that level. Countries that experienced a deep real estate slump during the great recession like the Netherlands, Spain and Ireland, are likely to even print growth figures above 3.0%. But the good news is that some of the member states that have been lagging, like Italy, are now also seeing signs of a more robust pick-up. At the same time a more reform oriented government in France seems to result in structural reforms that might lift the growth potential of the French economy. The German juggernaut still doesn’t show much signs of slowing after seven years of expansion.”

“The recovery is now self-reinforcing, as higher demand is leading to rising employment in all sectors of the economy, boosting disposable income, thereby also lifting consumption growth. Even the strengthening of the euro is not having much of an impact on export growth, which remains quite robust.”

“Against the backdrop of a stronger economy, financial markets don’t seem to be too worried about political tensions. The conflict between the Spanish central government and the Catalonian government is not causing shockwaves on financial markets. And the Italian elections, that have to be held before May 2018, don’t even seem to be on market radar screens anymore. That said, the stronger cyclical recovery has not solved the fault lines in the set-up of the Eurozone. While new French president Macron had the intention, through a strengthening of the French-German axis, to foster a more integrated Eurozone, the German election results have squashed hopes for far reaching reform.”

“Meanwhile, inflation has remained too low, with the stronger euro exchange rate not really helping the ECB to bring inflation back close to 2.0%. In that regard the ECB can hardly do anything else other than continue with its extremely loose monetary policy. However, as the QE program is now increasingly hampered by bond scarcity issues, the ECB will have little other choice than to reduce the monthly amount of purchases. However; we believe the bank will mitigate the potential negative market effect of such an announcement by lengthening the QE programme longer than the market expects, potentially until the end of 2018. This would also make the forward guidance that interest rates will not be increased before the end of the QE programme more powerful, implicitly delaying the first rate hike until 2019.”