The wait for a recovery in the Eurozone has been frustratingly long. While the final composite purchasing managers' index reading was fractionally above expectations at 51 for January, the figure points to only a tepid rate of growth and is down from 58.8 in the same month last year. The German government recently lowered its growth forecast for this year to 1%, down from 1.8% just a few months earlier. And after two consecutive quarters of economic contraction, Italy has dipped into recession.
This helps explain why forward markets are suggesting that the European Central Bank (ECB) won't raise the deposit rate until around the middle of 2020, and that rates will remain in negative territory until the middle of 2021.
Despite the unexpectedly prolonged weak patch, however, it remains likely that Eurozone economy is not heading into recession:
- The ECB will remain supportive. Just as the US Federal Reserve has been eager to allay fears that it will undermine growth or markets in the US, so too the ECB is signaling that it will seek to protect the economy. This will take the form of patience in tightening policy. We also expect the ECB to announce measures to assist the banking sector as repayment dates for the targeted longer-term refinancing operations loom.
- There are pillars of strength in the Eurozone economy overall, notably the labor and housing markets. The consumer in Germany is being supported by record low unemployment, rising salaries and low diesel and gasoline prices. As a result, the German government is expecting consumption to account for 0.7% of the overall 1% growth rate this year, a greater share than in previous years. Net wages are expected to rise by 4.8% this year. House price growth for the Eurozone has accelerated, climbing 1.6% in 3Q18, up from 0.5% in the first quarter of the year.
- Eurozone consumption should also be underpinned by relative weakness in the oil price, with Brent down from USD 87/bbl as recently as October to USD 62/bbl at present. While we expect oil prices to trend higher, the Eurozone – a large net importer of oil – should benefit from the dip.We do not expect Eurozone growth to rebound to 2017's 2.5% pace. But we still see the region avoiding recession with growth of around 1.1% this year. That is consistent with our overweight in global equities.
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