Europe at a crossroads: Recession or turnaround?Contributors Tilmann Galler, Ambrose Crofton
With limited help available to the eurozone economy from within, an improvement in external factors might prove the key for a turnaround.
Since the start of 2018, the European economy has continued to disappoint investors. A multitude of factors, both external and domestic, have contributed to a backdrop of slowing economic growth. A revival in growth in China is the most likely catalyst for a turnaround-but perhaps later in the year.
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.
However, 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?
Looking at the detail of the slowdown, it appears that much of the weakness can be attributed to net exports. Net exports 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 their contribution was negative. Both sides of the equation-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 external factors aren’t the only ones to blame: 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. The prolonged period of political uncertainty has taken its toll on the Italian economy, with the country technically falling into recession.
In France, the protests of the “gilets jaunes” (a movement focused on social inequality) have caused significant disruption, sending the French composite purchasing managers’ index into contractionary territory at the end of 2018. Impetus in the protests now seems to be waning and growth data for the fourth quarter of 2018 held up surprisingly well. But 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 autos industry has struggled to get to grips with the new emissions testing regulations, hampering industrial production and dragging significantly on growth. After a difficult fourth quarter of 2018, German auto production now looks to be picking back up (Exhibit 1), which could be a near-term boost to growth.
EXHIBIT 1: GERMANY NEW CAR REGISTRATIONS
% change year on year, three-month moving average
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