Low oil prices and supportive policy to drive recovery in Eurozone 

eurozone-ecb

After a year of tentative recovery in 2014, the Eurozone has moved into 2015 aided by two important growth drivers – sharply lower oil prices and QE according to the March 2015 issue of the EY Eurozone Forecast (EEF). These two factors will support a domestic recovery that began in 2014, helping GDP growth accelerate from 0.9% in 2014 to 1.5% this year and then 1.8% in 2016.  

  • Lower oil prices and Quantitative easing (QE) to lift Eurozone GDP growth to 1.5% in 2015 and then 1.8% in 2016
  • Modest fall in prices in 2015, but no slide into deflation as improving economy strengthens pricing power – inflation at -0.2% in 2015 and 1.1% in 2016
  • Consumer spending growth to accelerate from 0.9% in 2014 to 1.6% this year, as households get windfall from lower energy costs

But the medium-term outlook remains constrained by a number of structural factors, in particular the need for fiscal restraint and the dampening effect on wage growth of high – but gradually falling – unemployment. These factors will mean growth should remain around 1.6% a year in 2017-19. Meanwhile, the crisis in Ukraine and difficult negotiations over Greek debt will continue to present a risk to economic and financial stability for some time.

The gradual improvement of the Eurozone economy – with consumers regaining confidence and the labor market continuing to gradually recover – will be supported in 2015 by lower oil prices, which are expected to average US$55 a barrel compared with about US$100 a barrel in 2014; we expect this to add 1% to 1.5% to real consumer incomes in the Eurozone in 2015.

Overall, the EEF estimates real household income will grow by 2.5% this year, enabling consumer spending growth to rise from 0.9% in 2014 to 1.6% this year. But as the degree of spare labor continues to hold back wage growth for some years, consumer spending growth is expected to remain steady around 1.5% from 2016 onwards.

Tom Rogers, Senior Economic Adviser to the EY Eurozone Forecast, says:

“Consumer spending growth is expected to be the strongest this year since 2007. Households should see a 10% to 15% reduction in their fuel bills. Since energy and fuels account for around 10% of the Eurozone consumer basket, real incomes should increase by 2.5% from 2014. Nevertheless, governments should continue to work on labor market reforms to tackle near-record levels of unemployment – which stopped rising in 2014 – and expand employment opportunities to groups such as the young unemployed and those with lower skill levels.”

Mark Otty, EY’s Area Managing Partner for Europe, Middle East, India and Africa, says:

“Households are clearly responding to the improved labor market environment and energy-related windfall. This stronger demand will present a number of growth opportunities across a range of consumer-facing sectors, but at the same time a depreciating euro means there might be a rotation toward domestically produced consumer goods. Firms need to be able to understand how the balance of these factors impact in their particular marketplace.”

Deflation fears provoke European Central Bank (ECB) action, aiding exporters

The downside to lower oil prices has been a further slide in headline inflation, from an already tepid 0.4% in October to -0.6% in January, and the intensification of fears about a prolonged spell of falling prices in the Eurozone.

The ECB’s subsequent plans for a major increase in the size and change in the scope of its asset purchases should substantially aid the recovery in the next couple of years. Through both the real economy and exchange rate impacts, inflation in the Eurozone is expected to pick up from -0.2% in 2015 to 1.1% in 2016, and then to 1.7% by 2019.

All other things being equal, this should weaken the euro from US$1.14 on average in February to just over US$1 by the end of 2015 according to the EEF, offering exporters across the Eurozone a substantial boost to competitiveness in global markets.

Positive domestic and external factors support investment

The improvement in the 2015-16 outlook, along with the range of past and present ECB measures, is set to trigger a rebound in capital spending over the next couple of years. Even if increasing demand for loans has not yet been felt by banks, conditions seem right for higher investment over the coming quarters.

Meanwhile, banks are also reporting improving access to wholesale funding markets, and lending rates across asset classes should be further compressed over the coming years by the ECB’s asset purchases. Therefore, rising demand for loans should be complemented by lower lending rates, strengthening the recovery in investment.

Looking ahead

Rogers says: “Governments need to take advantage of this period of improving economic conditions to cushion any short-term impacts from reforms, so that their long-term payoffs can be realized. Priorities vary by country, but further labor market reforms, amendments to tax and benefits arrangements and entitlements, and regulation of product markets would all improve long-term growth prospects. Governments should not be tempted to avoid making hard decisions simply because the crisis appears to have passed.”

Otty says: “The improving financial and economic situation presents businesses with a key choice – do we invest for the future, or take profits now, possibly at the expense of longer term competitiveness? The balance between these two factors will be different across sectors, but could be tipped toward investment and job creation by further improvements in business environments across and within Eurozone economies.”

Source: Ernst & Young

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