17 September 2018
Eurozone: That late summer feeling

The Eurozone economy is still showing decent growth, but the pace of growth is likely to level off over the next two years, as the international environment has become less positive. At the same time a number of political hurdles can inject some uncertainty into the growth outlook but still we expect 2.0% GDP growth this year

Growing divisions

In his State of the Union, Jean-Claude Juncker, the president of the European Commission, made it clear the European Union has only 250 days left until the European elections in May 2019 to prove to citizens this Union is capable of delivering on expectations. 

Indeed, the populist wave in Europe is weakening further European integration, and a victory of less European minded parties could further undermine the stability of the Union. That’s why Juncker pleaded for a strengthening of the European borders and a reform of Europe's asylum system, as the wave of immigration has been one of the important tailwinds for populist politicians over the last few years.

As punishment beckons for Hungary, the process could lead to the country being stripped off its right to vote in the Council - which highlights the growing divisions in Europe

Juncker also urged a further deepening of the Economic and Monetary Union (EMU), while simultaneously championing a more global role for the euro. Again these goals necessitate a lot of political cohesion which doesn't really seem to be happening at the moment. 

Political tensions within Europe remain present, with the European Parliament voting to initiate the so-called Article 7 process against Hungary for violating some of the core European values. This process could lead to a country being stripped of its right to vote in the Council of the EU. While it is improbable it'll go that far; it shows the growing divisions within Europe. 

Even if the Italian budget passes without too much fuss with the European Commission begrudgingly approving (our scenario), the Italian government might harden its stance later on Eurozone reforms

The new Italian government has also been on a confrontational path with the EU since the beginning of its mandate: first on immigration, and the next battlefield could be the budget. Fortunately, the latest declarations indicate that all deficit rules will be more or less respected. But even if the budget passes without too much fuss with the European Commission grudgingly approving (our scenario), the Italian government might harden its stance, e.g. on Eurozone reform, later, especially if the European elections strengthen its position. 

The Italian 10-year bond yield shot up from 1.6% in May to around 3.30% at the start of September, partially reflecting redenomination risk. Fitch’s recent change of the rating outlook to negative didn’t help either. Fortunately, the less combative sounds emanating from the Italian government recently led to a relief rally, though it seems too soon to sound the all clear signal.

Germany: Late is not too late

Between the late-cycle and the golden decade, the German economy is experiencing an unusual fluctuation in high-frequency data but the underlying trend remains robust. Could feel a bit like an Indian summer of sorts for a while

Contrary to the national football team, the German economy didn't have a rude awakening at the start of the summer. Instead, the economy returned as an outperformer of the Eurozone. The economy grew by 0.5% 2Q18 from 0.4% in the first quarter, on the back of strong domestic demand.

Like the US, Germany  faces the question whether an economy in its tenth year of expansion is about to slow down or whether the old saying that economic recoveries never die of old age still holds

At face value, the current expansion remains impressive. The economy has been on a growth path for 34 out of the last 37 quarters, private consumption has been growing for 18 consecutive quarters, and even investments have started to increase significantly over the previous two years. Despite the international criticism, the German economy is already showing a very balanced growth model.

Like the US economy, Germany faces the same question whether an economy in its tenth year of expansion is about to slow down or whether the old saying that economic recoveries never die of old age still holds.

France: Emmanuel Macron 2.0

After a difficult summer which saw his approval ratings plummet, President Macron is starting his second year in a weaker position. If the number of ambitious reforms on the agenda are as high as the last, the French economy will be less supportive. We forecast GDP growth of 1.8% this year, a notch below 2017’s 2.0%

Back to school

President Macron started his year by attending a class in a primary school which benefitted from one of his key first-year reforms, limiting the number of pupils per class for children aged five to six. 

If past reforms have been slowly digested, President Macron now seems stuck in moving sands: isolated on the European scene while he made it a key reform area, affected in the polls by the judiciary troubles of one of his security guards, and losing two of his most popular ministers.

It seems that Mr Macron has slightly changed his ways, favouring a less “Jupiterian” approach to domestic politics and consulting more widely both with his ministers and social partners

His approval ratings have declined from 40% to 32% in the Ipsos political barometer between April and September. The departure of Nicolas Hulot, the French environment minister, could affect this approval rating further as the reason for his departure has to do with the very reason why Mr. Macron was elected, namely to prove that France can be reformed. If his most popular minister doesn't believe it anymore, it's hard to say that the second year of Macron's presidency has begun well. 

Nevertheless, it'll be a busy year with several wide-ranging reforms scheduled, notably for unemployment benefits and pension regimes and the headcount cuts in the administration. 

On the European side, he'll have to deal with the risk of a no-deal Brexit, with strong political opposition to his Eurozone reinforcement project and a potential political crisis with Italian populists in the European election campaign. 

It seems that Mr Macron has slightly changed his ways, favouring a less “Jupiterian” approach to domestic politics and consulting more widely both with his ministers and social partners. This seems like an absolute minimum to regain approval and avoid a political meltdown at the European elections which are going to be a strong political test in May 2019 and for which the President’s party needs allies that have so far proven hard to find on the French political scene.

So far, the macroeconomic context of 2018 hasn't helped much. However, confidence and activity surveys show that there could be an uptick in the coming months and we think that the economic context should slowly be more supportive, before turning again at the end of 2019.

Italy: Budget test for the 5SM/League government

The inconsistencies between a challenging 5SM/League attitude on budgetary issues and finance minister Tria’s reassuring statements finally seem close to a solution. The compromise will unlikely be able to shift a gear in the current modest recovery, but we still expect the Italian economy to expand by 1.1% in 2018 and by 1% in 2019

Unconventional governance for an unprecedented government

The first three months of prime minister Giuseppe Conte's government, backed by the unprecedented alliance between the Five Star Movement and the Northern League, have been unconventional. 

Matteo Salvini and Luigi Di Maio, the leaders of the two parties which signed the government “contract”, have been continuously holding the scene, while prime minister Conte has played the role of the incidental notary, settling disputes when deemed necessary. 

Salvini, the interior minister, set the scene on the migrant's issue, often challenging the European Union and European partners on burden sharing instances. While Di Maio, one of Italy's two deputy prime ministers and in charge of both economic development and the labour and welfare ministries, concentrated mostly on labour-related issues and has so far managed to gain parliament's approval to tighten labour laws and curb temporary job contracts.

The Netherlands: Domestic momentum stays

The Dutch economy continues to grow above potential thanks to strong domestic demand, and as long as hard Brexit and trade war fears don't materialise, we forecast GDP growth of 2.8% this year and 2.5% for 2019, which is still above the Eurozone average

Soft indicators fell, but still point to strong growth ahead

The outlook for the Dutch economy is still rosy, even though a number of survey indicators are currently lower than when they were at the peak, around the turn of the year. 

We forecast GDP growth of 2.8% for this year and 2.5% for 2019, which in both years is above the potential growth rate and the Eurozone average.

Strong domestic demand makes Dutch GDP growth less vulnerable to risks abroad than in recent years

While geopolitical tensions seem to have affected the mood, the sentiment is still more positive than the historical average in services and industry and especially in construction. Purchasing managers' index shows the industry is more optimistic about domestic order positions than new export orders, however continuing export growth may be combined with downward risks for foreign demand. Fortunately, strong domestic demand makes Dutch GDP growth less vulnerable to risks abroad than in recent years.

Spain: Political challenges ahead as the economy slows down

The next couple of weeks are likely to be stressful for the Spanish prime minister as he confronts a number of thorny issues. Meanwhile, evidence of a slowing economy is mounting. For 2018 as a whole, we forecast a growth rate of 2.6% and 2.0% for 2019 

2019 budget is the first political hoop

Parliament's rejection of the draft 2019 budget was the first serious blow to prime minister Pedro Sanchez's minority government. Only 88 parliamentarians (out of 350) voted in favour of the plan at the end of June, so the first political hurdle is the approval of the 2019 budget.

 A deal between Sanchez and Pablo Iglesias would mean the prime minister can be more confident about Podemos support in parliament 

Spain's leftwing party, Podemos, which holds 67 seats, didn't support the draft budget as it wanted softer deficit targets. However, Sánchez emphasised the importance of fiscal discipline and continued to pursue the deficit target of 2.2% of GDP. Finding a compromise will be difficult, and as the draft budget needs to be submitted to Brussels by 15 October, the pressure will increase.

Recently, however, Sánchez met with Pablo Iglesias, the leader of Podemos, to talk about common goals on education, housing and taxes. A deal between the two would mean Sánchez can be more confident about Podemos support in parliament and this increases the probability of budget approval and the chances that Sánchez governs until the next official elections in 2020.

Belgium: An election year in sight

The Belgian economy continues to grow at a moderate pace. Having said that, the labour market is still doing well. In the short term, we don’t expect many economic policy changes, as the long election period has just begun

Weak consumption

Despite being positive, Belgian economic growth disappointed once again in the first half of this year at 0.3% and 0.4% in the first and second quarter respectively.  

What is interesting is that while domestic demand was the biggest contributor to economic growth in 2017, things seem to be changing this year. Foreign trade contributed as much as domestic demand in the second quarter of this year, while the contribution of inventory changes was negative. Unfortunately, we can't say foreign trade contribution increased, but rather it was the domestic demand that decreased.

 Domestic demand was the biggest contributor to economic growth in 2017, things seem to be changing this year

The evolution of household consumption remains the main handicap to more dynamic domestic demand. It increased only by 0.2% in the first half of the year, which is very low. For sure, households nominal disposable income rose in the second quarter by 2.9% year on year. This is due in particular to a decent increase in employment (+39,000 jobs during the first six months of the year). 

However, considering the nearly 2% inflation, this leaves little room for consumption to increase in real terms. As a consequence, Belgian households have once again reduced their savings rate, (which is now below 11% and remains below the European average) to maintain the weak growth rate of consumption. 

Greece: Thinking about life after the bailout programme

The almost ‘clean’ exit from the third programme leaves Greece with many challenges ahead, the first of which will be devising a sustainably higher path of growth while sticking to the reforms. But in the short run, the upcoming elections will be the first credibility test 

The volatile economic recovery continues

The Greek economic recovery continues at a moderate pace, with a volatile pattern of growth. In 2Q18, GDP expanded modestly at 0.2% quarter on quarter (1.8% YoY), slowing down from an upbeat 0.9% in 1Q18. 

The wounds of the global financial crisis and three adjustment programmes are still visible as total employment is still 17% below pre-crisis highs

Exports were the growth driver, while investments have so far failed to confirm the exceptionally positive reading of 4Q17. The flipside of this was a softer growth drag from the goods component of imports. The good news came from the private consumption front, which is finally benefiting from the ongoing turnaround in the labour market. Employment has been expanding at an average 1.5% year on year rate over 1H18, and the unemployment rate has recently fallen again below the 20% mark for the first time since 3Q11. 

To be sure, the decline in the unemployment rate, while an undisputable positive, should be put into context, as it happened during the sharp contraction of the Greek labour force. The sustained pick-up in consumer confidence is finally showing up in hard consumption data, which posted two 0.5% QoQ increases in a row in 1Q and 2Q18. The wounds of the global financial crisis and three adjustment programs are still visible as total employment is still 17% below pre-crisis highs.

Ireland: Fingers crossed for a deal

The Irish economy continues to show healthy signs of growth despite the Brexit uncertainty. While a no deal scenario could have significant ramifications, confidence is still high and modified domestic demand doesn't show any signs of slowing either  

Consumption catchup possible if cliff-edge situation avoided

The Irish economy continues to grow strongly despite the uncertainty around its future. GDP growth in the first quarter disappointed, but economic fundamentals continue to point to a stronger year for the Irish economy.

A decline in consumption despite continued strength in the labour market seems to reflect some of the uncertainty surrounding Brexit and trade disputes, but the drop in investment growth seems to reflect the swings in multinational corporation activity, impacting GDP negatively this quarter. This might be due to the changes in the American corporate tax system. 

Expectations for the next 12 months, which is now well past the March 2019 Brexit date, don't seem to have adjusted for a worst-case scenario, so the outlook for consumer remains quite bright

Modified domestic demand, which strips out multinational activity components, actually accelerated in the first quarter, which indicates domestic investment performed well at the beginning of 2018.

Even though consumption weakened in the first quarter, the outlook for consumers remains quite bright as expectations for the next 12 months don't seem to have adjusted for a worst-case scenario. After the referendum, general economic expectations in Ireland deteriorated somewhat, but have actually been recovering since early 2017. Expectations about consumer’s financial situation and employment prospects have been stable at historically strong levels, which indicates that without a cliff-edge situation Irish consumption seems to be set for some catch-up in the second half of the year.

The Irish housing market continues to face supply worries, which means house prices are likely to continue to rise throughout the year. The 12.3% year on year growth in Q1 saw Dublin's price growth being outpaced by the rest of the country, indicating housing shortages are broad-based for the moment.  

Portugal: On track for another good year

The government continues to focus on reducing public debt and the deficit however strong house price growth is becoming a concern. We expect the economy to continue to perform well in 2018, although growth will be slower than last year and forecast annual growth of 2.1% in 2018 and 1.8% in 2019

The discussion about the 2019 budget is ongoing, but it seems the Portuguese government continues to focus on limiting the budget deficit and public debt. 

The prime minister António Costa recently said the country should continue to do this to protect itself from external risks, such as a further escalation of the US-China trade war. In 2017, the Portuguese government debt in terms of GDP was the third highest in the Eurozone (125.7%), after Italy (131.8%) and Greece (178.6%). Costa recently said that the aim for 2019 is a deficit of 0.2% of GDP, which is even lower than last year’s 0.9% excluding the one-offs such as the recapitalisation of the public bank Caixa Geral de Depósitos.

The draft budget is expected to be given to the parliament and the European Commission by 15th of October, after which it will be discussed in parliament, while the vote on the bill would take place at the end of November.

In 2017, the Portuguese government debt in terms of GDP was the third highest in the Eurozone (125.7%), after Italy (131.8%) and Greece (178.6%)

In the second quarter, the economy grew by 2.3% year on year, compared to 2.1% in the first quarter. Like the first quarter, net exports contributed negatively to growth, but domestic demand, and in particular consumption and investment, more than compensated. Consumption remains supported by a strong labour market. The unemployment rate continues to drop sharply and reached 6.8% in July. Employment growth has been declining since the beginning of the year but managed to stay above 2%. Soft data, such as consumer confidence and the Economic Sentiment Indicator (ESI) remain at high levels.

The unemployment rate continues to drop sharply and reached 6.8% in July

One issue that gets more and more attention is the sharp increase in house prices, which have been accelerating since early 2015 and reached 12.2% in the first quarter of 2018. This is almost twice as fast than Spain and three times as fast as the Eurozone. The strong growth rate is caused by surging domestic and foreign demand, while supply cannot keep up.

The government could take some measures in its 2019 budget to alleviate the pressure, for example curbing foreign demand by adjusted programs such as the golden visa and the non-habitual regime. However, the prime minister has recently announced that people who return to Portugal in 2019 and 2020 could get a reduction in income tax and discounts on their return trip and housing, which is likely to further exacerbate the problem.

Austria: Still enjoying the isle of happiness

2018 marks another boom year for the Alpine republic, but for 2019 and 2020 we expect a gradual return to average growth levels cooling down to 2.2% and 1.8% respectively 

Economic performance driven by domestic and foreign impulses

With first-quarter GDP growth coming in at 0.8% quarter on quarter and second-quarter growth at 0.7% QoQ, Austria’s economy has seen a strong first half of the year. While we expect the current strong momentum to abate as the peak of the current economic cycle has been reached, a robust growth performance of 2.8% for 2018 is pencilled in. 

Although risks to the growth outlook stem from foreign uncertainty factors such as a further escalation of the US trade conflict with major trading partners, the impact should be negligible for the Austrian economy this year. For 2019 and 2020 we expect a cooling down to 2.2% and 1.8% respectively.

Finland: Peak growth?

The Finnish economy continues to outpace the Eurozone average in 2018, but a maturing cycle, weakening competitiveness and more uncertainty about the global environment will cause growth to deteriorate. Our outlook for 2019 and 2020 is more modest from 2.6% this year to 1.6% in 2020

Has Finland reached the top of the growth cycle?

After a surprisingly strong first quarter with GDP growth of 1.2% quarter on quarter, the Finnish economy has slowed to 0.3% in the second. 

The significant drag in the second quarter was the volatility in government expenditures. Consumption and fixed investment both accelerated in Q2 though, indicating that domestic demand is gaining traction. Export growth continues to contribute positively to GDP as growth has resumed.

 All in all, 2018 looks to be another strong year for the Finnish economy, but downside risks are beginning to impact the growth outlook. While the recovery only started in 2Q15, it looks like growth is set to slow down in the coming years as external and internal factors take effect.

Eurozone housing market cycle is maturing

The residential real estate market has been recovering in the Eurozone since 2012. However, ECB’s quantitative easing program has boosted prices everywhere since mid-2015 through lower long-term interest rates that boosted mortgage credit growth. We think 2018 could see peak growth but expect the recovery to slow down after that 

Eurozone: House price recovery continues

In 2014 and 2015, we saw house price growth rates below 2%, but in 2016, prices rebounded by 3.4% accelerating to 3.7% in 2017. We think 2018 could see peak growth as we forecast 3.8% but then a decelerating trend for the coming years. 

Nevertheless, house price growth should remain above inflation, with growth forecasts of 2.8% and 2.6% respectively for 2019 and 2020. 

Reading time around 19 minutes

ING’s Eurozone Quarterly: A late-cycle economy?

Rising protectionist sentiment, the populist wave across Europe, a looming Brexit deadline and talks of a maturing cycle are all factors that seem to be playing a part in the slowdown of Eurozone’s growth. One could say the expansion is now in late summer: the temperature still feels nice, but we know that the best is behind us

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