Looking at leading indicators and the eurozone economic outlook, the scene is set for strong growth, in our views. Taken literally, results from surveys including the purchasing manager indices (PMIs) or the economic sentiment index point to 3% to 4% year-on-year (YoY) growth. Such a rate looks unlikely to us. Trend growth in the eurozone has been between 1% and 1.5% and without any strong stimulus from fiscal spending, a weak euro or low oil prices, an acceleration from the current 1.9% year-on-year rate is not what we foresee.
Exhibit 1: Eurozone GDP growth and PMI surveys
Source: Bloomberg, Markit, BNP Paribas Asset Management, as of 06/07/2017
That does not mean we are negative on the eurozone economic outlook. Consumers may miss the fillip that falling inflation gave to their wage packets last year, but employment growth of more than 1% YoY and falling unemployment should support household income, even if the output gap is still large.
And there is room for investment to grow further. In the second quarter of 2017, capacity utilisation in the industrial sector crept to its highest in almost 10 years.
Financial conditions have remained favourable, with credit spreads holding close to record lows and bank credit to non-financial companies growing mildly.
Export growth has surged recently, although the impact on the overall economy was mitigated by an equivalent increase in imports.
Inflation remains stubbornly low
Core inflation jumped to above 1% in April for the first time since October 2015, but slipped back to 0.9% in May. The energy-driven spike in headline inflation has started to reverse, causing headline consumer price inflation to fall to 1.4% in May. Five-year forward inflation (the average five-year inflation expected five years from now) has fallen from 1.8% at the end of January to below 1.6% at the end of May.
Exhibit 2: Eurozone inflation (YoY changes in %) – the underlying rate of inflation remains at close to 1%
Source: Bloomberg, BNP Paribas Asset Management, as of 06/07/2017
Despite low inflation, the tone from the ECB has changed recently. President Mario Draghi acknowledged that the economic upswing is becoming increasingly solid and, in June, the ECB stated that “the risks to the growth outlook are now broadly balanced, which marks an upgrade from “risks are still tilted to the downside”.
With regard to inflation, the ECB’s governing council has acknowledged that there has been no evidence of a feed-through into prices: “The economic expansion has yet to translate into stronger inflation dynamics. So far, measures of underlying inflation continue to remain subdued”. Even if Mr Draghi noted that there was no formal discussion of policy normalisation at the June council meeting, we believe in an implicit agreement within the policysetting forum that a tapering of quantitative easing will be announced after the summer and that QE will stop relatively soon, with the timetable largely independent of the data.
In this context, we expect the September meeting of the council to decide on the future of the asset purchases in 2018. The council has indicated its “communication should be adjusted in a very gradual and cautious manner” [Account of the monetary policy meeting held on 26-27 April 2017] to avoid triggering excessive market disruptions if any such changes were to be interpreted as signs of a shift in monetary policy. More than ever, caution appears to be as important as clear communication.
Written on 06/07/2017