Europe’s downside risks increase

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Weak eurozone growth and inflation are a concern, leading us to downgrade our growth and inflation forecasts for the region. The UK economy, however, continues to power ahead.

Weak growth in Q2

Official estimates show the eurozone stagnated in Q2 following poor performance in core Europe. The notable exception was the strength of the UK, where the economy expanded faster than any of the other major European economies for the second quarter in a row. Seasonal factors are partly responsible for the slowdown in aggregate eurozone GDP growth, but geopolitical tensions as a result of the Ukraine crisis may also have impacted confidence.

Low inflation – policy response?

Inflation has also been disappointingly low, which, in combination with weaker-than-expected growth, has prompted a lowering of medium-term inflation expectations. Recent comments by European Central Bank (ECB) President Mario Draghi appear to have been interpreted by the market as the ECB preparing for quantitative easing (QE). While his speech was clearly dovish, we struggle to see the ECB announcing more aggressive measures like sovereign debt QE when extra liquidity to banks will be released next month, and possible asset-backed securities purchases are still being worked on. Markets may be in for disappointment at the September ECB meeting.

Eurozone forecast update

We have lowered the forecast for eurozone GDP growth in 2014 to 0.8% and to 1.2% in 2015. The main downgrade has been to German growth, given the contraction in the second quarter and softer leading indicators. We have also reduced our eurozone inflation projections to 0.7% in 2014 and 1.1% in 2015.

UK forecast update

Overall, the forecast for UK growth is largely unchanged. We have revised the 2014 figure up to 3%, but expect the economy to slow to 2.5% in 2015 as the general election could prompt companies to delay business investment. We continue to forecast the first rate rise in February 2015, with 25bps of hikes per quarter. However, the risks to our forecast are skewed towards slower and later rises, not only because of the lack of pay growth, but also our forecast for inflation towards the turn of the year.

 

Azad Zangana is European economist at Schroders

 

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