John Fahey: Eurozone economy struggles for momentum
Last week saw the final ECB meeting of 2019 and the first one with Christine Lagarde as president. The meeting itself was largely uneventful.
As expected, the central bank left its current policy stance unchanged. The ECB is likely to keep policy on hold in the months ahead. This is to allow time to assess the impact that the significant easing package it announced back in September has on the economy.
These measures included a cut of 10 basis points to the deposit rate from –0.4% to –0.5%, as well as restarting its quantitative easing — or QE — asset purchase programme.
However, the ECB continues to state that it is willing to ease monetary policy further, if required. The reason it retains this easing bias is because of the subdued level of economic activity and inflation in the eurozone economy.
Eurozone GDP growth held at a weak 0.2% in the third quarter, leaving the year-on-year rate at 1.2%. Consumer spending was the main source of growth in the quarter, while net trade acted as a slight drag.
The national data showed that growth in the region remains uneven. Germany narrowly avoided a recession in the third quarter, but the economy has essentially stagnated. The same is true of Italy.
In contrast, activity is holding up reasonably well elsewhere, with the French and Spanish economies, for instance, continuing to register solid GDP growth. There are signs that the labour market is beginning to feel the effect of the softening of economic activity. Employment grew by just 0.1% in the third quarter, with the year-on-year rate slowing to below 1%.
Meanwhile, inflationary pressures remain subdued. The headline measure was recorded at 1% in November, while core inflation printed at 1.5%. These rates are well below the ECB’s 2% target. Leading indicators of activity suggest that the eurozone economy may have lost further momentum in the last quarter of 2019.
The composite PMI averaged just 50.6 in the fourth quarter, down from 51.2 in quarter three. The PMI reading is at a level consistent with practically stagnant activity. This lacklustre economic backdrop is reflected in the ECB’s latest macro forecasts.
The central bank is projecting eurozone GDP growth of 1.1% for next year. It is forecasting only a modest pick-up in growth in 2021 and 2022, with a 1.4% rate pencilled in for both years.
Meanwhile, inflation is expected to remain well below the 2% target in the next couple of years. Inflation is forecast at just 1.1% in 2020 and 1.4% in 2021. The ECB envisages inflation averaging 1.6% in 2022.
The ECB continues to be of the view that the risks to the economic outlook remain tilted to the downside. Given that the eurozone economy is heavily reliant on export-led growth, the prospects for the global economy will be a key determining factor in the region’s economic performance.
In this regard, the recent progress between the US and China in phase one of its trade talks is a positive development as it reduces some near-term risk for the global economy. So, also, does the prospect now of an orderly departure of the UK from the EU at the end of January.
These are further grounds for the ECB to leave policy unchanged. Markets are now of this view also. They no longer expect the ECB to cut rates any further. Instead, they see rates remaining unchanged right throughout 2020 and 2021.
