The Eurozone: two steps forward – one step back
Despite the signs of improving global business confidence since the beginning of the year many economic fundamentals in the euro area remain weak and unpredictable, according to the spring Ernst & Young Eurozone Forecast (EEF). This is why forecasts indicate overall decline of 0.5% in GDP for 2013. Sluggish growth of 1.1% is predicted for 2014. This will be followed by slow-paced expansion in subsequent years averaging 1.4% per annum from 2014-17, almost a full percentage point below the 2.3% average in the Eurozone of a decade before.
Closing the gap between the core and periphery
Despite the contrast in growth between the Eurozone core and periphery there are some tentative signs that the situation beyond the core nations is improving. EEF expects the pace of contraction in the periphery to slow from 1.9% in 2012 to 1.4% in 2013, before a return to growth in 2014. This is primarily due to painful work being undertaken by certain countries in the periphery to reform their economies which is already yielding results in the form of improving international competitiveness.
Since 2008, employment in the periphery has fallen by 9% or 5 million people. In the case of Spain, Ireland and Portugal, employment has fallen further than output, thereby providing a boost to productivity. The falls in relative unit labor costs have made the goods and services produced in these peripheral economies more competitive than they were five years ago.
By 2014, EEF expects the peripheral eurozone countries with the fastest export growth to be Greece, Ireland and Spain – 9.3%, 4.4% and 4.1% respectively. These are the three countries that have seen the largest improvement in their relative unit labor costs, and hence competitiveness, since 2008. This will help these countries exit recession and allow gains in economic activity to accompany job creation.
The return to very modest growth that we expect to see in the peripheral countries in 2014 will initially be driven by business investments and exports and subsequently, once the labor market starts to improve, by consumer spending.
Unemployment rate will remain high
EEF predict that unemployment in the Eurozone will reach a record high of 12.4% by the end of 2013, with the jobless rates in Spain and Greece at more than 26.5%. Even with recovery, the number of people out of work across Europe will remain stubbornly high. By the end of 2017, EEF estimates the unemployment rate will remain above 11%, and the number of unemployed will be around 6.5 million higher than a decade before.
Consumers’ willingness to make new purchases will be hampered by further increases in unemployment in 2013. Ongoing fiscal tightening and austerity measures will also have an impact on household spending. Consumer spending is expected to fall again in 2013, by 0.6%, before starting to grow slowly by an average of just 1% a year in 2014-17.
Banking sector deleveraging will also continue to constrain growth over the forecast horizon. Although the banking system is now much less of a systemic threat to the broader economy than a year ago, it is not yet in a position to drive an economic upswing through rapid lending growth. Generally, tight credit conditions will weigh on investment and consumer spending.
Euro stays strong, but not for long.
Although the economic climate remains difficult, confidence among businesses and consumers should return gradually, as some of last year’s major threats recede. But business investment is still expected to shrink by 2% in 2013, before recovering slowly to post average growth of 3.5% a year in 2014-17.
The euro has already surrendered some of its earlier gains, but it is still up by 8% against the US dollar and 8.5% on a trade-weighted basis since mid-2012. In the current climate the impact of the appreciation will be mitigated by the fact that it is accompanied by a more stable environment. However, the export sectors from the periphery may suffer from the appreciation of the euro and if sustained it may undo some of the painful work undertaken to restore competitiveness.
Despite these concerns, EEF has not lowered its growth or export forecasts as it does not expect the rate to stay at its current level for long. EEF estimates that the euro is overvalued by a little under 10% at present. But, as uncertainty about the US fiscal stance clears and the pickup in growth there and in emerging markets becomes more obvious, EEF expects the euro to depreciate again towards USD 1.25 by the end of this year.
Fiscal tightening hinders GDP growth
Fiscal tightening is also expected to be a medium-term drag on growth. EEF estimates that fiscal tightening will amount to more than 1% of GDP again this year, which will cut around one percentage point off GDP growth. From 2014 onwards, the pace of fiscal tightening should lessen, but at around 0.5% - 1% of GDP a year, it will continue to dampen growth.
After several years of austerity, one of the key challenges now facing policy-makers in the Eurozone – both in the peripheral countries and most others – is to apply public sector reforms in a way that does not continue to undermine growth.
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