The periphery’s 2015 outlook
By Willem Verhagen, Senior Economist at ING IM
Peripheral economies are displaying an increased degree of political polarisation. To a considerable extent this is the result of the economic hardship these countries endured over the past few years which among other things is being expressed in very high rates of unemployment and very low or negative wage growth.
To some extent an economic slowdown following the bubble years was always inevitable as imbalances have to be worked off. Nevertheless, in our view the peripheral downturn was aggravated unnecessarily due to misguided concerted fiscal consolidation and the fact that EMU policymakers procrastinated in implementing a decisive solution for the crisis between 2010 and 2012. It was only after the ECB stepped in with the OMT (conditional lender of last resort for sovereigns) that the crisis calmed down.
Moreover, policymakers started to recognise that fiscal austerity in a depressed economy only makes things worse. As a result, countries were given more time to meet the medium term fiscal targets. On the back of all this and due to advances in competitiveness and corporate health in Spain, Ireland and Portugal peripheral growth has displayed an uptrend over the past year.
Nevertheless, in view of the remaining imbalances, especially in Italy and France, and a failure of the core countries to accelerate all this has not proven sufficient to put EMU growth on a firmer footing. What’s more, lowflation has become a prominent and persistent feature throughout the region even in Germany which is roughly at full employment. This has now started to drag inflation expectations lower which is a dangerous process since it can easily gain a momentum of its own.
It is therefore of the utmost importance that the ECB embarks on a large and rapid expansion of its balance sheet which will require it buy sovereign bonds. We expect this to happen in Q1’15 and we believe that throughout the year this is likely to prove to be the dominant force for peripheral spreads.
To the extent that these sovereign bond purchases are successful in raising peripheral nominal growth expectations this policy should at least at the margin also help to reduce the political polarization in those countries as well. Having said that, it is clear that reform fatigue is deeply rooted in some countries and discontent with current governments is further increased by some political scandals. In this respect, the elections next year are certainly a risk factor. The Portuguese and Spanish elections will only take place in Q4’15 which in our base case provides a time window of more than 6 months for sovereign QE to exert its beneficial effects on peripheral financial conditions and confidence.
The Greek situation is of course very different and somewhat fluid now that the Presidential elections have been pulled forward to the end of this year. There is a distinct probability that Samaras will persuade a sufficient number of independent MPs to vote for his candidate because these independents know they could well lose their seats in an early general election.
However, if the latter cannot be avoided it could well lead to a large victory for the Syriza (far left party). It is not clear to what extent this party could come to an agreement with the Troika about the necessary steps to be taken after the two month extension of the EFSF programme expires. Incidentally, in the case of ongoing uncertainty about the Greek program we do not expect this to be an impediment for sovereign QE because the ECB has announced it will only buy below investment grade sovereigns if these countries are in an official programme.
Finally, the Italian labour market reforms are definitely positive and fit in the big picture where Prime Minister Renzi is willing to push through difficult political and economic reforms in an effort to make the country more governable and improve its dismal productivity record. We believe these efforts should be rewarded with policies that support the demand side, i.e. less fiscal austerity and more monetary easing.