10 January 2018
Eurozone economy ends 2017 with a bang

The Economic Sentiment Indicator ends 2017 on a high note but the inflation picture still remains muted

The Eurozone economy is going from strength to strength. The European Commission’s economic sentiment indicator (ESI) surged to 116 in December from 114.2 in November, which is way above the 114.8 consensus expectation. The Business Climate Indicator rose to 1.66, hitting its highest level since 1985.

With the growth picture looking very strong, calls to end the ECB’s expansionary monetary policy will only grow louder

There was a sentiment improvement in all sectors (industry +1.0, services +2.0, retail trade +1.9, construction +1.2 and consumer confidence +0.5). But the country breakdown revealed a strong increase in sentiment in Germany +1.6 and France +2.3. 

Amongst the other large euro-area economies, the ESI rose in the Netherlands (+0.7), while it remained unchanged in Italy (0.0) and slightly decreased in Spain (-0.8). One should also note that the sentiment indicator is now above its long-term average in Greece.

The Eurozone economy is definitely gaining momentum and a GDP growth figure this year at or above 2017’s expected 2.4% cannot be dismissed as a fairy tale. However, the inflation story remains more of a mixed bag. 

As we saw last week, core inflation still remains too low to get comfortable, and the Economic Sentiment Indicator doesn’t shed any more light on this matter. Some pipeline inflation is starting to show as selling price expectations increased strongly in the industry and to a lesser extent in construction. But at the same time selling expectations fell slightly in services and retail sales, while the consumer is also pencilling in fewer price increases over the next 12 months.

With the growth picture looking very strong, the calls to end the ECB’s expansionary monetary policy will grow louder. 

On Sunday the president of the Bundesbank, Jens Weidmann in an interview with the Spanish daily El Mundo said that the ECB should set an end date for its asset-buying program. That said, a majority within the Government Council will want to avoid the repeated mistake of premature tightening, certainly given the stubbornly subdued inflation dynamics. 

We still expect a short lengthening of the asset purchase program until December 2018, to allow further tapering. While net asset purchases will definitely have ended in the first quarter of 2019, a first rate hike might have to wait until next years summer.

The Eurozone: Going into overdrive

The Eurozone recovery seems to be going into overdrive. For how long can that continue?

Eurozone indicators close to historical highs

The Eurozone recovery seems to be going into overdrive. The €-coin indicator, a proxy for the underlying growth momentum, hit 0.91% in December, suggesting an above 3% annualised 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.

With employment rising 0.4% in the third quarter, consumer confidence in December 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. No wonder that most cyclical indicators are close to historical highs. The PMI indicator for the manufacturing industry in December hit the highest level since the series started in mid-1997.

A year of tough decisions for the UK

Several challenges lie ahead for Brexit, leaving the Bank of England with a conundrum

December's breakthrough helps unlock a transition period agreement

As a turbulent 2017 finally drew to a close, politicians on both sides of the channel were finally able to breathe a sigh of relief. After months of deadlock, an agreement was reached on the UK’s financial liabilities, citizens’ rights, and ultimately most contentiously, the Irish border.

December’s breakthrough means that a transition period looks set to be agreed by the end of the first quarter. Admittedly such an agreement won’t be legally binding until the full exit treaty is ratified later this year. But a firm commitment by both sides that there will be a ‘status quo’ transition period until late 2020/early 2021 should be enough to prevent firms enacting their ‘no deal’ contingency plans.

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