Eurozone (EZ) GDP growth now looks likely to slow to just 1% this year according to a report published by Fitch Ratings‘ Economics team. The deterioration in growth prospects and declining inflation expectations will prompt the ECB to consider restarting asset purchases.
Economic activity data from the EZ has deteriorated more sharply than other parts of the world in recent months and has delivered the biggest negative surprise relative to market and Fitch’s own expectations.
“While numerous transitory factors are partly to blame, these cannot explain the breadth and depth of the slowdown. Rather, we believe that the slowdown has been primarily the result of deterioration in the external environment as net trade turned from a tailwind to a headwind,” said Fitch’s Chief Economist, Brian Coulton.
The domestic slowdown in China has, we believe, played a particularly important role here. Germany’s greater trade openness and larger exposure to China leave the largest European economy’s expansion more vulnerable to China’s domestic cycle and import demand. This is underlined by Germany having seen the biggest deterioration in activity data among the EZ economies – despite a healthy domestic economy with few of the imbalances that typically spark an abrupt downturn in domestic demand. Furthermore, the deterioration in manufacturing Purchasing Managers’ Indices (PMIs) since last summer has been greatest in countries with a large auto export sector, dragged down by the first decline in global car sales since 2009 and the first fall in vehicle sales in China for several decades.
The weakening in EZ external indicators has not been matched in the domestic economy. Labour market performance remains strong supporting household income growth, monetary policy remains supportive, bank lending conditions are easy and credit to households and businesses continues to grow. Only in Italy have we seen evidence of private sector borrowers reporting somewhat tighter credit availability. Fiscal policy is also being eased in the EZ and should be supportive of growth in 2019. Private sector debt ratios have improved significantly since 2012 in Italy, Spain and Germany.
EZ growth should recover through the course of 2019 as the policy response in China helps to stabilise its economy from the middle of the year, one-off impediments to growth in Germany unwind, and EZ macro policy is eased. However, early indications for 1Q19 and the profile of our China forecast mean that there will not be much of a pick-up in EZ quarterly growth before 2H19.
This suggests that EZ growth in 2019 is likely to be around 1% compared with our December 2018 GEO forecast of 1.7%, a substantial cut. Both Germany and Italy will see similar revisions, with 2019 GDP growth now forecast at around 1% and 0.3% respectively. Even with this lower forecast, downside risks remain from an escalation in global trade tensions, a deeper slowdown in China, a disorderly no-deal Brexit or increased uncertainty related to domestic political tensions.
The sharp deterioration in growth prospects and falling inflation expectations are likely to result in renewed monetary stimulus measures from the ECB.
“We had already been expecting the ECB to delay the start of its policy normalisation -both interest rates and balance sheet reduction – but we now believe it will seriously consider restarting QE asset purchases relatively soon,” added Robert Sierra, Director in Fitch’s Economics team..
We also foresee the ECB announcing a one- to two-year long-term refinancing operation (LTRO) in March to replace the existing TLTRO2 programme, which matures from June 2020. The rationale for a new targeted LTRO (TLTRO) is less convincing in light of improved conditions in the banking sector, but the ECB will want to avoid an unwarranted tightening in credit conditions by abruptly withdrawing liquidity facilities.
