Eurozone: After the summer lull - RBS

Research Team at RBS, notes that the Eurozone and broader world economy have been in relatively calm waters over the past few weeks.

Key Quotes

“Leading indicators suggest that Eurozone economic activity has been holding up pretty well after the UK’s Brexit. This week’s regional flash PMI surveys certainly indicate little sign of growth deceleration in Q3 so far. And inflation outcomes have been surprising to the upside in the past few weeks, albeit modestly, assisted in part by some energy-related base effects. Risk assets in the meantime have rallied strongly, partly driven by firming growth expectations and still-loose global monetary policy settings.

We expect the ECB to remain in ‘wait and see’ mode at the next meeting on 8th September. The minutes from the July meeting confirmed that no detailed discussions were held on the specifics of the QE programme’s design. The time horizon of the programme was mentioned, which suggests that the duration of the bond-buying programme could soon be extended beyond March 2017. While more detailed discussions on this and the programme’s duration are likely in September, it may be too early for the ECB to act, given limited attention to “flexibility” and overall re-design of the QE programme so far.

At a broader global level and from a longer-term vantage point there has been heightened conjecture in recent weeks that greater fiscal policy activism will emerge from the world's major economies in the coming months spurred in part by the size and scope of Japan’s recent fiscal package. A broadly-based fiscal loosening among the major economies has much to recommend it given the ongoing paralysis in the world economy. With interest rates close to the zero bound (and mostly negative in real terms) some commentators have argued quite fiercely that a boost to government investment could be pretty effective in boosting global growth.

We are not convinced by this narrative, however, for a number of reasons. Firstly reaching broad political agreement on the merits of fiscal policy expansion will not be easy against a backdrop where government indebtedness in a number of major economies is at record highs. Pre-election rhetoric will probably be very different to the post-election reality. Secondly fiscal stimulus, whether it is co-ordinated or not, will still not tackle some of the key issues that are generating excess savings and lacklustre growth in the world economy at present.

Those issues concern, among other things, ageing demographics, new technologies, China’s cyclical – and structural - slowdown (and broader EM implications) along with that aforementioned record-high level of indebtedness. Thirdly, global economic and financial imbalances - another critical reason for lacklustre global growth - will probably fester in the period ahead and more likely worsen even with greater fiscal policy activism. That’s partly because of the domestic focus of many Central Banks’ monetary policies and their likely exchange rate consequences.”