18 January 2018
Eurozone: Full speed ahead

The Eurozone economy is set for a fourth consecutive year of above-potential growth in 2018. While the output gap is gradually closing, inflation is only expected to rise very slowly, keeping in place expansionary monetary policy throughout the year

It's all systems go!

The Eurozone recovery seems to be going into overdrive. As far as confidence indicators are concerned, 2017 ended with a bang. The European Commission’s economic sentiment indicator (ESI) surged to 116 in December from 114.2 in November. The Business Climate Indicator rose to 1.66, hitting its highest level since 1985. Since October 2016 the Economic Surprise Index has been continuously in positive territory, reflecting an uninterrupted stream of economic indicators coming out better than expected.

The €-coin indicator, a proxy for the underlying growth momentum, hit 0.91% in December, suggesting an above 3% annualized growth pace. While we doubt that this pace will be maintained throughout the year, we believe that GDP growth in 2018 will be at least as good as in 2017. That would be the fourth consecutive year of above-potential growth. With employment rising 0.4% in the third quarter, December consumer confidence hit its highest level since January 2001, boding well for consumer expenditure.

Rising supply constraints and generous financing conditions are likely to continue to underpin the business investment revival. Notwithstanding the strong euro, export perspectives remain upbeat. The rebound in global investment is particularly helpful for Eurozone exports. The assessment of export orders in the manufacturing sector is now at the highest level in 10 years.

Germany: Change would be good

The German economy continues its almost everlasting boom. The next new government should add some minor fiscal stimulus in the coming years, without going for the big economic strike

An impressive growth performance

Germans don’t like change. In this respect, 2017 was an excellent year and 2018 has all the ingredients to be another good one. Growth was and should remain strong; all economic sectors were and should continue to be booming and Angela Merkel was and should remain Chancellor. However, at least a little bit of change is urgently needed.

The economy grew by 2.2% (2.5% when adjusted for working days) in 2017. That's a much stronger performance than expected one year ago.

Germans don't like change. Therefore, 2017 was a good year and 2018 should also be good

Back then, the German recovery already looked rather stretched. Sentiment indicators stagnated and political risks were rising from Brexit and the upcoming Dutch and French elections. Meanwhile, the new US administration was fuelling fears of possible trade wars. One year later, the lesson is clear: “it was not politics, but economics, stupid”. A strong labour market, low-interest rates and low inflation pushed the domestic economy into sixth gear. Also, instead of suffering from protectionism or a Trump trade war, exports surged to new record highs and the long-awaited investment pick-up finally kicked in. The result: the strongest annual growth performance since 2011. Of the last 35 quarters, the economy grew in 32, with an average growth rate of 0.5% QoQ. That's an impressive performance.

That growth performance is even more impressive given that it has been achieved without any significant structural reforms in the last ten years. In this regard, the German economy is actually a good example of how an economy can benefit extensively from earlier reforms, at least if the external circumstances are right.

France: Shifting into higher gear

The picture has changed dramatically in France in just a year. With the highest confidence levels in a decade, it's hard to ignore the positive effects of the reform atmosphere which we expect to continue in 2018

There is no alternative

Back in the summer of 2017, the polls were suggesting an unconvincing start for President Emmanuel Macron and his government. His approval rating has plummeted, and in August we were among those who thought they could hardly go any lower. Only Mr Macron’s base looked satisfied with his first steps, but five months later, all of that has become history. 

An IPSOS poll indicated in January 2018 a 53% approval rating for the President and almost 60% for Prime Minister Edouard Philippe. Part of it is due to the disarray of the opposition in polls, and another is the lack of stability at a low level on the right. President Macron seems to leave no space for an alternative. His first successes on the Labour Law and the 'moralisation law', which didn't trigger the feared street opposition, give a sense something is finally happening.

This should continue, with expected 2018 reforms to ease businesses’ life cycles from creation to transmission. The Government should also start spending its 50bn euro investment plan, which also entails new employment schemes for the unemployed. On top of that, the Government will have to take risks on two politically sensitive reforms: the Immigration Law and Constitutional Reform, which aims to lower the number of MPs and limit the number of offices they can hold. President Macron is therefore likely again to be all over the place in 2018, showing France that there is no alternative.

One could note that the Philippe Government does not look keen on austerity as the bulk of the 80bn euro of spending cuts scheduled for the next five years have been pushed back to after 2020. If the target is still to reduce public spending from 55% to 51.1% of GDP between 2016 and 2022, delaying the process could bring the deficit to GDP ratio above 3% in 2020, although stronger growth will help the consolidation of public finances.

Italy: Election time, finally

Italy is approaching the 4 March general election with the economy in full recovery mode, but there's a high chance of an inconclusive result

Domestic demand drive continued in 3Q17

Italy is approaching election time with the economy expanding at a decently good pace. But don't expect a clear-cut election victory for any party. Forming a new majority will take time and a caretaker government, headed by the current Prime Minister, Paolo Gentiloni (pictured with Germany's Angela Merkel last year) would help contain the risk of a confidence crisis.

Economic prospects are looking decidedly more promising. In the third quarter of last year, Italian GDP expanded by 1.7% YoY, driven by domestic demand. Interestingly, private investment continued gaining ground, overtaking private consumption as the leading contributor to quarterly growth. A solid export performance was behind the marginally positive contribution of net exports to quarterly growth. The unexpectedly sharp decline in inventories was a cause for temporary concern, as forward-looking indicators suggest a possible rebalancing in 4Q.

The Netherlands: Maintaining strong growth momentum

The Dutch economy should maintain a high growth rate in 2018; it's broad-based, consumer spending is high but labour market pressures are appearing

Domestic demand is driving economic growth

We forecast GDP growth of 2.9% for the Netherlands in 2018. Increasingly, growth is driven by domestic demand; consumers keep spending more and business investment continues to grow. On top of that, the coalition agreement of the new Rutte III government involves additional public spending. This will provide an additional boost to domestic demand and prevent growth from slowing down considerably after the impressive GDP figure projected for 2017. New policies also explain the upward revision of our 2018 forecast. The additional spending comes at the expense of public finances. Nevertheless, a budget surplus is projected for 2018 (+0.5% GDP).

Spain: Decelerating after a great run

After three years of above 3% growth, we expect momentum to slow somewhat in 2018 and 2019. The situation in Catalonia will not be resolved anytime soon and could be a further drag on the economy

The growth momentum

In terms of activity in 2017, there is nothing to complain about. With an annual growth rate projected to be 3.1%, Spain remains one of the fastest growing economies in the Eurozone. Growth momentum remains healthy for now, as PMIs for both the services and manufacturing sectors ended the year on a high note.

Domestic demand, which has provided a positive annual contribution to growth since the first quarter of 2014, continues to be the main driver of growth. As in 2016, private consumption remained the largest contributor to growth in 2017, although its importance declined. In contrast, the contribution of investment rose. In the third quarter of 2017, the YoY growth contribution of investment of 1.2 percentage points equalled that of private consumption.

External demand was another growth engine

Despite the troubles in Catalonia, Spain saw a record number of visitors in 2017, with the number of tourists increasing by nearly 9% YoY. However, with imports now also accelerating on the back of stronger domestic demand, the positive growth contribution of net exports was somewhat smaller in 2017 than in the previous years.

The labour market performed well last year. In the third quarter, employment grew at 2.8% YoY. Accordingly, the unemployment rate declined to 16.4% in the third quarter from 18.9% a year earlier. For 2018, we expect the unemployment rate to be 16% before dropping to 15% in 2019. This positive evolution, however, is still likely to result in a higher unemployment rate than before the financial crisis of 2009 and remains one of the highest in the Eurozone. The projected decline in unemployment will nevertheless continue to support private consumption in the coming quarters, although to a lesser extent.

Greece: Waiting for the exit debate to become serious

The Greek economy is finally back on a recovery path, driven by domestic demand. While the growth pace has so far been unspectacular, things are improving 

Back on a recovery path

Macroeconomic fundamentals have been improving in Greece. Labour market indicators have turned around. In 3Q17 employment was growing at 2.6% year-on-year, helped by a strong summer tourism season. The unemployment rate continues to decline, reaching 20.5% in September. 

Crucially, the combination of an improving economic backdrop and consistent signals that fiscal austerity had come to an end, have been reviving confidence indicators, and consumer confidence in particular. 

The approval of the 2018 budget was accompanied by the so-called social dividend - money handouts paid to Greek citizens hit particularly hard by the crisis, agreed with the institutions within the framework of the Third Greek programme. Public finance developments over 2017 have been positive in general, with good chances that Greece will meet its 1.75% of GDP primary surplus target. To be sure, tax collection issues remain but the government proved able to compensate by controlling expenditure.

Eurozone: Housing market to remain strong

Housing markets have been recovering in the Eurozone since 2012 mostly supported by low-interest rates, supply shortages and increased demand

Across the Eurozone

After a growth rate of 2.3% in 2016, house prices have grown by 3.5% in 2017. This growth has been supported by interest rates that remain very low, supply shortages in some countries and an increase in disposable income and hence demand. In 2018, we expect house prices to grow by 3.3% which is slightly higher than our previous forecast.

With consumer confidence at its highest level since 2001 and still very generous financing conditions, the recovery should continue, which in turn is positive for activity levels and employment growth. Business confidence in the construction sector reached levels in 2017 not seen in the last ten years and hiring intentions followed. This is likely to decrease supply shortages where they still exist, limiting house price growth somewhat in the whole Eurozone in 2018. 

In 2018, we expect house prices to grow by 3.3% which is slightly higher than our previous forecast (3%), due to the upward revision of forecasts in some countries.  While still being a high figure, it implies a slight slowdown compared to 2017, which is logical as long-term interest rates should start to make mortgages slightly more expensive this year. This should continue in 2019 where we expect a 2.8% price growth. Having said that, house price growth should remain firmly above inflation. 

As a final note, keep in mind that the 3.3% expected growth figure is a weighted average of all the constituent countries of the Eurozone that can have very different individual situations.

Portugal: Riding the growth wave

Portugal's economy will grow more than 2% this year, helped by some mild fiscal stimulus. But with lingering bank issues, a spending splurge is unlikely

Domestic demand drives growth

The Portuguese economy is still riding the growth wave with no sign of a slowdown. In 3Q17, private consumption (which added 1.7% to growth year-over-year) and gross fixed capital formation (which contributed 1.6% YoY) were confirmed as the main drivers of annual GDP growth. Despite a substantial export drive, net exports acted as a drag on growth (-0.9% YoY).

Belgium: Labour intensive growth

In 2018, we expect Belgian economic growth to accelerate further amid a broader Eurozone recovery

Domestic demand drives growth

With 1.8% GDP growth, 2017 can be considered a positive year for the Belgian economy. Domestic demand is mainly responsible for that figure, as it has been for the last four years. To be sure, its contribution to GDP growth was slightly below the level of previous years (Fig. 1), but we believe this was due to temporary factors: a lack of confidence amongst businesses in the middle of the year (it has been restored since then) and the fact that rising disposable income did not translate into more household spending. Fortunately, the positive contribution of both net external trade and inventories compensated for the somewhat weaker domestic demand.

This year, we expect a further acceleration of Belgian economic activity. First, domestic demand is expected to pick up speed, supported by high consumer and business confidence, but also by the delayed impact of job creation over the last two years (see below) and the expected further improvement of the labour market. Second, taking the high degree of openness of the Belgian economy into account, it is likely to benefit significantly from the strong activity in the Euro area. That’s why we expect 2.1% GDP growth in 2018.

Austria: It’s all systems go!

Austrian growth is robust, helped by good old-fashioned fiscal stimulus

Broad-based growth

All signs are pointing to an ongoing and robust Austrian growth story; the Austrian economy is likely to have hit the 3%-mark in 2017, a level last seen ten years ago. Political quarrels are largely off the table and the new government has already started working.  Growth is broad-based, driven by strong domestic and foreign influences, and it's also helped by a buoyant upturn in consumption, industry and investment. And that strong momentum is set to continue throughout  2018.

Finland: The strongest growth in a decade

The Finnish economy is powering ahead, but domestic demand could slow

The Finnish economy continues to thrive with GDP growth likely exceeding 3% in 2017. This is the strongest growth that Finland has experienced in 10 years. Growth performed particularly well thanks to strengthening exports, which are profiting from improving global growth. Exports to other Eurozone countries increased by 25% YoY in October, after a decline of about 8% in the year before. Exports to Sweden also improved markedly at 12% YoY growth in October, with exports to Russia and China increasing as well.

Improving global growth will likely contribute to continued export growth this year as all main export partners except Sweden are expected to see GDP growth maintain its current pace or even accelerate. Domestic demand could slow somewhat with wage moderation curbing consumption. The positive impact of lower wages on competitiveness is unlikely to fully offset the effects on consumption, bringing down our forecast for Finnish growth to 2% this year. The political environment is unlikely to have much of an effect this year as the presidential elections are expected to be won by the incumbent, Sauli Niinistö.

Ireland: Brexit concerns persist

Ireland continues to perform well, but Brexit worries are cause for some concern

A sigh of relief after the first round of Brexit negotiations: a no deal scenario has thus far been avoided and the current deal on the Irish border is promising. A possible deal that there will be full alignment in terms of regulation between the EU and the UK on issues affecting the Irish border is reassuring for the Irish economy and decreases the tail risk of moderating growth because of Brexit.

It remains difficult to see how full alignment with the EU can continue if the UK starts to change regulation though, so tail risk on the partial agreement persists. The infamous Brexit phrase “nothing is agreed until everything is agreed” still holds and a “no deal” scenario is also still a possibility. It, therefore, remains a positive first step, but uncertainty prevails.

With that said, the Irish economy continues to perform very well despite Brexit worries. Growth in Q3 increased to 10.5% YoY, mainly on improving net exports. This will bring the annual growth rate to around 6.5% for 2017. It is not just exports that cause strength, Ireland maintains healthy consumption growth boosted by continued labour market recovery. The housing market continues to experience upward pressure on prices as demand outstrips supply in the real estate market for the moment.

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ING’s Eurozone Quarterly: All systems go

The transformation in the Eurozone's economic fortunes has surprised even us. So what’s really going on, and will the across-the-board growth story continue throughout 2018? Find out in ING's new look Eurozone Quarterly Update

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