Once again I was invited by the Financial Times to contribute to their annual polls of economists drawn from major banks, brokers, think tanks and independent consultancies. This week I am concentrating on the Euro Area and next week will switch to the UK. Readers may be interested in my responses in the context of any consensus or lack thereof. Clair Jones, the FT’s Frankfurt Bureau Chief, penned the article:
All the responses are available in detail on the FT website and I shall only summarise them here. I have added some further comments in reaction.
1. Growth prospects What is your forecast for eurozone growth in 2018? Please enter a percentage.
AW response: 2.2% vs. a median of 2.3%
Consensus : all 31 forecasts were 2% or above
2. Price expectations What is your forecast for eurozone inflation in 2018? Please enter a percentage.
AW response: 1.3% vs. a median of 1.5%,
Consensus: well below the ECB’s target of 2%.
Comment: This reflects my long-held views that global inflation will remain subdued no matter how hard Central Banks try to manufacture it: too many unskilled workers, too many consumer goods and surplus commodities (oil’s current spurt will encourage marginal suppliers). Some economies (notably the UK but not the EA) will, of course, continue to be exposed to plunging exchange rates.
Chart 1 Après le déluge: Euro Area GDP since 2008
3. Recovery The eurozone’s recovery was exceptionally strong in 2017. Will it remain that way in 2018? Please explain your answer.
AW response: Unlikely to remain exceptionally strong but should stay above 2%, which is a result when one looks at its erratic progress since inception. Global growth will help but ironically less trade with the UK will be a drag.
Consensus: Something of a fudge as even 2.6% in 2017 is not really exceptional by international standards but 2% or more still looks good compared to the EA’s performance in the years since the GFC (Figure 1). Nevertheless, none of us in last year’s poll forecast the surge in 2017.
Comment: I continue to see EA growth being flattered by recovery after successive very poor years in several member economies rather than heralding a new common dynamism. My point on reduced trade with the UK reflects the current slowdown in the UK itself rather than any fall-out from the Brexit negotiations…at least not yet.
4. Risk What is the biggest threat to the eurozone’s recovery in 2018? Please explain your answer.
AW response: No obvious new risks. More like continuing drags: unemployment, aging population, non-performing bank loans, Stability and Growth Pact austerity constraints.
Consensus: cautious to mildly euphoric optimism.
Comment: Manufacturing is back and nowhere is better at it than Germany, France, Italy and the Netherlands. Purchasing Manager Surveys in all 5 of the largest economies (including Spain) and for the EA overall are at or near record highs. The Services Sector is picking up steam too with the December Services PMI is at its highest since April 2011.
Chart 2 Euro Area economy underpinned in 2018
5. Single currency Will the euro fall or rise against the dollar in 2018?
AW response: fall I am not alone but in a rather small minority.
Consensus: Most respondents forecast little change rather than a rise.
Comment :My forecast is not contrarian but based on political challenges that will not be easy to resolve. Brexit is only one of the challenges but post-exit budget squabbles are already beginning. The current speculative buying of euros does, however, make me suspect a change of direction once big profits have been made in the first few months of 2018 and carrying on from April last year.
6. French politics Will Emmanuel Macron’s reform agenda have a positive effect on the eurozone’s economy in 2018?
AW response: Yes but his impact will take longer to bear fruit.
Consensus: High expectations of Mr Macron were reflected in the FT headline for the poll and this is where I differed the most from other respondents.
Comment: The real problem with Mr Macron is that there appears to be no sensible alternative.
7. German politics Would another Grand Coalition in Germany be a good or bad thing for the eurozone economy?
AW response: Probably beneficial as SDP will want to increase public spending.
Consensus: Perhaps surprisingly, most respondents were neutral on this in the short term, albeit some are more concerned about voters in the long term tiring of the dominance of two parties with so many similar centrist policies.
Comment: Germany has a fiscal position that the rest of Europe can only dream about and the SPD can surely think of plenty of ways of spending more. So a renewed ‘GroKo’, which looks increasingly likely in the light of Mrs Merkel’s somewhat plaintive New Year message, should be good for the economy if not for politics.
8. US rate hikes What effect with the US Federal Reserve’s interest rate hikes have on the eurozone economy?
AW response: Not much as so well flagged and likely to be delayed if stock market has a major correction.
Consensus: similar to my own view.
9. Brexit What will be the economic impact of the Brexit discussions on the eurozone economy this year?
AW response: negative but not hugely so as an exit from the Single Market starts to look less likely from the spring onwards.
Consensus: Most respondents seem to agree that downside is limited and some because they deem UK trade of little importance.
Comment: My increasing conviction that the UK will not leave the Single Market for at least 5 years clearly puts me out on a limb but is actually based more on practicalities than expectations of an easy or quick UK-EU accord. Dismissing the impact of UK trade is not good economics.
10. ECB QE When will the European Central Bank’s net bond buying end?
AW response: In 2019.
Consensus: Mine is a minority view with 2018 much more favoured with December just ahead of September.
Comment: The ECB may be running out of suitable bonds to buy but it is also running out of ideas on how to stimulate inflation and encourage more bank lending.
11. Eurozone interest rates When do you expect the first rate hike in the eurozone?
AW response: in the first half of 2019.
Consensus: My view is shared by a majority of respondents but several think that the ECB will hold off until the second half.
Comment: The EUR/USD exchange rate is likely to be decisive and interest rate differentials (gold line in Figure 3) appear to have become irrelevant since last summer (white line). Unless ‘normal service’ is resumed soon the ECB will remain loth to hike at all.
Figure 3 ECB dilemma: Euro marches on even as Treasury vs. Bund yield spreads widen again
12. Fiscal policy You are placed in charge of a new eurozone fiscal authority with the power to spend as much or as little as you see fit. What do you do next?
AW response: Long-term escalating programmes to tackle the political, economic and social problems of unemployment, age-care and un-integrated immigrants. Some traditional supply side stuff (physical infrastructure, skills training, seed capital) plus more imaginative projects (housing, basic business skills, micro finance, even local cultural events) to bring people together to help each other and themselves. Practical and localised with Not for Profit organisations bidding for funding. (Have I gone soft?)
Consensus: Other respondents clearly have not gone soft and settled for a bit more infrastructure spending and a lot more on skills training while some hawks did not want to do anything at all.
Comment: The arguments about debt levels-both public and private-continue to rage. Figure 4 was produced primarily to show the challenge of private sector deleveraging in China (which is probably 2019’s biggest global economic threat) but also shows how exposed are the French and Italian economies. The need to keep helping out those two countries (especially their deficit-addicted governments) is another reason why the ECB will keep both buying indefinitely at least some bonds and holding down interest rates. This is palliative rather than radical to my taste.
Figure 4 G20 growth fuelled by the wrong sort of borrowing?
13. Structural reform If you could impose one major reform on any eurozone economy, what would it be? Please say why.
AW response: Not strictly economic but what would have a major impact would be reform of the Italian legal system including depoliticising and splitting up the roles of the magistrates. Italy could do so much better!
Consensus: More axe-grinding here but Italy featured in many other responses including references to judicial reforms while France and Germany got a few mentions. Bank reform was also mentioned by several respondents.
Comment: A date has finally been set for the Italian elections (March 4th) and the outcome looks to be even more chaotic than usual. All the parties are offering a mix of traditional ‘goodies’ mixed with ‘reforms’. As a regular visitor to Italy I am very aware of its strengths and weaknesses but am still shocked by the inadequacy and iniquity of the civil law. It would be good to see the points in Figure 5, many of which are related, feature in party manifestos.
Figure 5 Most needed reform in Italy : killing contracts
Source: Johannes Kepler University