The eurozone’s economic recovery has ground to a halt, triggering demands for aggressive intervention by the European Central Bank (ECB).
Germany, France and Italy delivered dismal GDP data in the second quarter. Germany contributed to a 0.2 per cent fall in economic output, France’s economy stagnated and Italy is in its third recession since 2008.
Stewart Robertson, Aviva Investors’ senior economist, believes these data are extremely worrying. “The eurozone ‘revival’ amounts to a total increase of a paltry 1 per cent since the second recession of 2011-12. This is almost what the UK and the US achieved in the last quarter alone,” he says.
He adds that coupled with very low inflation (0.4 per cent in July), these data show that the risk of renewed stagnation and deflation in the area is a very real one and that the ECB should be doing more to help.
Kerry Craig, global market strategist at JPMorgan Asset Management, regards the most worrying aspect of the second-quarter data as Germany, due to its role as the key powerhouse in the region and the serious impact any weakness in its economy will have for the eurozone as a whole.
“Investor and business sentiment in Germany has fallen sharply in recent weeks as the increasingly volatile situation in Ukraine and European sanctions against Russia have weighed on investors’ minds,” he explains. “However, the economic contraction is more likely due to weaker demand from other eurozone countries, namely France and Italy.”
He says Italian prime minister, Matteo Renzi, has had some (albeit limited) success across four key areas of reforms, but that monumental challenges remain. That said, much of the negative news is priced in, with the MSCI Italy index remaining 54 per cent below its 2007 pre-crisis peak.
Joshua McCallum, UBS Global Asset Management’s head of fixed income economics, says he is less gloomy, pointing out that everywhere in the eurozone, the survey data still point to positive growth. “The exception is France, where both the hard [GDP] and the soft [survey] data give a consistently weak message, which is why we have been pessimistic on France for some time and remain so,” he says.
“Germany will resume stronger growth, at least by German standards, given that the currency union has given them an interest rate and an exchange rate that is geared to the eurozone as a whole, but is exceptionally loose for Germany’s needs.
“Spain is likely to continue its buoyant recovery as some of the reforms of recent years start to pay off, but Italian growth will remain muted.”
So what is the potential for economic growth across Europe and are the weaker economies having a major impact?
Azad Zangana, Schroders’ European economist, says the house view is for growth across the eurozone as a whole of roughly 1 per cent in 2014 and 1.4 per cent in 2015, slower than before the financial crisis, but even this may be too optimistic.
“Weak countries are holding back growth elsewhere, but not in a dramatic way,” he claims. “Weakness in core countries has not stopped Spain and Portugal outperforming in the second quarter. We would be more concerned if the weakness risked causing a sovereign or banking crisis, but there is little risk of this at present.”
James McCann, Standard Life Investments’ UK and European economist, thinks potential growth is being held back by debt overhangs in the public and private sectors and weak productivity, and that structural reform is needed to boost potential growth rates and improve the outlook for debt sustainability.
Anna Stupnytska, Fidelity Worldwide Investment’s global economist, says that looking towards year end, the company expects a challenging growth environment, with the region lagging behind the rest of the developed world.
She thinks that monetary accommodation from the ECB and a stronger global economy, driven by the US and China, should help support a mild acceleration in growth. Exporters such as Germany should benefit, she adds, especially in the context of the currency’s recent weakness, although the Ukraine crisis could be a negative factor.
So are economists changing their forecasts for European growth because of the weaker countries?
Both Schroders and Standard Life Investments think so. Mr McCann says growth forecasts for 2014 have been revised lower, as the pace of recovery disappoints and geopolitical risks have triggered downward adjustments to expectations.
UBS’s Mr McCallum is more upbeat, saying economists’ forecasts have been surprisingly stable since the start of the year and that although forecasts for 2014 will mathematically fall after the weakness in the first half, forecasts for the rate of growth in the second half have been so far remarkably stable at roughly 1 per cent.
But what has caused the weakness and could it spill over into the eurozone?
Mr Zangana attributes the eurozone’s economic woes to a lack of competitiveness and that, historically, weak economies would have devalued their currencies to regain their competitiveness. But trapped in the euro, they must reform and internally devalue, which can be very deflationary and risky, especially during a period of subdued external growth.
“We think the weakness will persist, but remain internal,” he says.
“There are indirect spill-over effects, but if anything, the poor performance of countries such as France and Italy should show countries like Spain and Ireland that reforms work, and might even encourage other countries to follow suit.”