Eurozone Recovery to be Slow and Painful

The negative impact of a weaker international environment on exports and ever higher unemployment numbers weighing on demand will continue to dampen growth, extending the recession further this year than previously predicted. Despite some positive signs of improvement across the region little or no pick up this year can be expected unless the ECB takes further significant action, according to the summer Ernst & Young Eurozone Forecast (EEF).


The forecast predicts a contraction of 0.6% in 2013, a slightly larger decline than in 2012. A very slow recovery is then expected in 2014 with GDP growing at 0.9% and around 1.5% a year in 2015-17. Unemployment is forecast to hit a peak of 12.7% of the eurozone workforce in Q1 next year.


The forecast also notes the shift in rhetoric from policy makers from fiscal austerity to fiscal credibility and estimates that halving the austerity measures currently planned would raise eurozone GDP by nearly 1% in 2014, with Greece and Spain benefitting most.


“In the short-term there appears to be very little that can help to improve growth across the eurozone," says Marie Diron, senior economic adviser to the

Ernst & Young Eurozone Forecast. "On the positive side the relaxation of fiscal austerity means that measures that would have otherwise been implemented that could have potentially harmed growth have been avoided.”


Lack of growth from emerging markets impacting eurozone growth

According to the forecast the delay in the recovery in the eurozone is partly due to the cooling in emerging markets particularly China and Brazil which are key export markets for the region and engines of global growth. This has outweighed the more positive news coming from the US.


The weak demand for eurozone goods and services will weigh on exports growth which has so far remained a bright spot for economies such as Germany, and even Spain. The steep depreciation of the yen is also limiting European export prospects by increasing competition from Japan.


More supportive Eurozone policy to facilitate growth
Given the lack of even fragile economic growth across the eurozone policymakers are turning away from fiscal austerity and towards fiscal credibility to facilitate growth.


The latest rate cut in May reflected both poorer growth prospects within the eurozone and the ECB’s determination to do something about it. However, at present low interest rates are not being passed through to the real economies in the periphery, where stimulus is most needed.


While the ECB’s current rates may be appropriate for Germany, monetary policy is far too tight for the peripheral economies.


Diron notes that an additional cut in rates would probably mean that the deposit rate would turn negative. This would hit banks’ profits and therefore be counterproductive.


The easing of fiscal targets announced by the European Commission in May removes the need for deeper spending cuts and revenue-raising measures which otherwise would have harmed growth in the near-term. Given the postponements of fiscal targets in France, Spain and Italy, it is now possible to envisage a scenario in which the eurozone moves toward abandoning austerity either wholly or partially. Were this to happen, growth would be higher than EEF has currently forecast.


Diron explains, “Halving the currently planned austerity measures would raise the level of Eurozone GDP relative to the current baseline by 0.2% in 2013 and by a further 0.7% in 2014. If this were to happen it is likely that Greece and Spain would benefit the most.”

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