Eurozone recovery to be slow and painful

July 23, 2013

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 EY Eurozone Forecast (EEF).

  • Unemployment now to peak in Q1 2014 at 12.7% of workforce
  • Emerging markets slow down hitting Eurozone exporters
  • Halving austerity measures could accelerate and deepen recovery

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.

EEF also suggests that more could and should be done to encourage reforms for banks to fund their lending to SMEs more cheaply.

Marie Diron, senior economic adviser to the EY Eurozone Forecast comments:

“In the short-term there appears to be very little that can help to improve growth across the eurozone. The structural reforms that are being implemented particularly across the periphery could take some time to have an impact on GDP. 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. But fiscal policy will remain restrictive.”

“However, the ECB can do more by easing monetary policy targeted at SMEs. The risks of attempting further support are far less than not doing anything at all.”

Mark Otty, EY Area Managing Partner for Europe, Middle East, India and Africa comments:

“Although the forecast predicts a peak in unemployment in the first quarter of 2014, the much delayed recovery could be hampered further if unemployment continues to rise impacting consumer demand. This will have a significant knock on negative impact on businesses across the Continent.”

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.

Unemployment to peak in 2014

In addition to a weaker global demand, the forecast predicts that unemployment will peak in the first quarter of 2014 at 12.7% up from the figure of 12.5% that EEF forecast last quarter, equivalent to an extra 500,000 unemployed workers and a total of 20.5 million.

Youth unemployment across the eurozone is also particularly high at 24%. In Greece and Spain it has reached alarmingly high levels at 59% and 56% respectively.

Marie comments:

“Eurozone unemployment has risen more than we had expected. The rise in unemployment reflects both the ongoing weakness in the external environment and the fact that austerity has been far more damaging to the economy than many early estimates suggested. Longer term high levels of youth and long-term unemployment will result in workers becoming deskilled and detached from the labor market, hindering the eurozone’s medium-term prospects.”

The weakness of the labor market will curtail household incomes and thus consumer spending growth over the next three years. As a result, EEF expects that private consumption to contract again this year, shrinking by 0.8%, before growing 0.5% in 2014 and just over 1% in 2015.

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.

Marie comments:

“An additional cut in rates would probably mean that the deposit rate would turn negative. This would hit banks’ profits and therefore be counterproductive. Moreover, it is simply not possible for the ECB to cut interest rates to the extent needed in the periphery.”

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.

Marie 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.”

Revival in lending to SMEs

A key objective for the ECB is to revive lending to small and medium-sized enterprises (SMEs) while simultaneously maintaining progress on fiscal reduction. Easing collateral rules in the Bank’s liquidity operations would enable banks to fund their lending to SMEs more cheaply. Although an early move to lift credit to SMEs seems unlikely, the potential is significant.

Marie explains:

“The forecast predicts if half the credit tightening that has happened since 2008 were reversed within two years, Eurozone GDP would increase by €65b, or 0.7% and unemployment would be almost 500,000 lower by 2017.”

Looking ahead

As Mark explains the pressure on eurozone finances does have some positive if painful consequences that should be acknowledged:

“Although the debt crisis and ongoing recession have severely impacted growth across the eurozone they have acted as a catalyst for structural reforms that otherwise might not have taken place. It may be cold comfort for European citizens half way through a lost decade but policy-makers are increasingly aware of the need to accompany fiscal consolidation with long-needed structural reforms which are necessary if the eurozone is to effectively compete on the world stage.”

Read more: EY Eurozone Forecast: Summer 2013

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