Since the start of 2018, the European economy has disappointed investors.
A multitude of factors, both external and domestic, have contributed to a backdrop of slowing economic growth.
Certainly, there was a lot of promise and expectation for European growth at the start of 2018. Fuelled by easy financial conditions and falling unemployment, the European recovery looked to be finally finding its feet.
Since then, economic data for the region has deteriorated significantly. As this weakness has persisted, investors have become tired of the seemingly perpetual excuses for weak data, and sentiment towards European assets has worsened.
With few domestic catalysts for a turnaround, it may take a rebound in demand from the emerging world to improve prospects for the region.
What has gone wrong for the European recovery?
Export growth at a standstill
Much of the weakness can be attributed to net exports, which contributed 1.4 percentage points to the annual real GDP growth rate in the fourth quarter of 2017, but in the third quarter of 2018 its contribution was negative.
Both imports and exports contributed to the deterioration, as the rising oil price in the first three-quarters of 2018 led to a sharp increase in imports, while at the same time export growth stalled.
Given that exports make up approximately half of GDP in the eurozone, a slowdown in global growth was always going to prove a strong headwind. In particular, demand from emerging markets has softened.
In November, exports to Turkey contracted by one third year-on-year due to the confidence crisis that led to a slowdown in growth and the devaluation in the currency, while export growth to Asia slowed because of a slowing Chinese economy.
But domestic factors have played their part too.
In Italy, the new coalition government’s dispute with the European Commission over its proposed budget sent borrowing costs to multi-year highs and tightened credit conditions.
In France, the protests of the ‘gilets jaunes’ have caused significant disruption, sending the French composite purchasing managers’ index into contractionary territory at the end of 2018.
Populism remains a risk across Europe, with the European parliament elections in May likely to show that Eurosceptic parties still garner significant support.
In Germany, the car industry has struggled to get to grips with the new emissions testing regulations, hampering production and dragging significantly on growth.
What could be the catalysts for a turnaround?
With the unemployment rate continuing to fall and wages picking up, the European consumer is still supported. In addition, the oil price has fallen significantly since October last year, serving as a significant tax cut for European households.
Historically, there has been a close inverse relationship between the oil price and consumption in the region, as the chart above shows, suggesting that the recent move in oil can help to boost consumption, and may also help European businesses by easing cost pressures.