The FINANCIAL — For the eurozone, 2015 is shaping up to be a testing year. The rise of populist political parties, a deepening Russian recession and turmoil in Greece loom against a backdrop of possible deflation, anaemic growth and ever-rising debt. With inflation at a five-year low and falling, while growth disappoints, governments continue to overshoot their deficit and debt projections.
But it’s not all bad. First, other peripheral markets have hardly reacted to Greece’s problems – although global investors, rather than confront the long-term question of how the ever-growing debt stock of many member states will be repaid, may be assuming that the European Central Bank (ECB) will save the day with full-blown quantitative easing.
Second, despite cutting our eurozone growth forecast for 2015 to a still below-consensus 0.9 per cent, the worst downgrades may now be behind us, thanks to sharply lower oil prices and a halt to fiscal consolidation – even though neither will provide a lasting basis for sustainable growth, nor lessen the enormous policy challenges.
Falling oil prices will likely push down gas, electricity and transport charges in 2015, leaving eurozone households with more to spend. Even with nominal wage growth slowing further, outside Germany, real wage growth should support consumer spending, particularly in Spain.
The impact on investment spending will be more mixed, however. The negative contribution from falling energy-related investment should be modest, but the positive impact on non-energy companies will also be muted, given the relatively small impact on corporate profit margins and investment.
Any revival in investment spending may have to come from the public sector. Fiscal policy should now be about 0.5 per cent of GDP looser than previously targeted in France, Italy and Spain and, by not enforcing fiscal rules on large eurozone countries, the European Commission is making fiscal slippage more likely in some smaller states, including Greece, Portugal and Ireland.
Annual real GDP growth of around 1 per cent in 2015-16 – and nominal growth of not much more – is far too little to make a material difference to the public finance and inflation trajectories for most eurozone members. There is little hope of debt stabilisation soon in any large economy except Germany.
Political uncertainties threaten to weigh on confidence in 2015 given the heavy election calendar in Europe, inside and outside the eurozone. The risk of policy reversals could delay consumer spending and investment.
The immediate concerns relate to Greece and falling eurozone headline inflation – which is likely to turn negative – and inflation expectations, pushing up real rates. A larger, more broadly based asset-purchase programme, including government bonds, will be needed to meet the ECB’s intention of returning the balance sheet to the early 2012 level of about EUR3 trillion.
The impact of full-blown quantitative easing is unlikely to be as positive as it was in the US and UK but the main channel of influence is likely to be the exchange rate. The burden of currency appreciation globally seems to be being borne almost single-handedly by the US dollar, which is making it hard for the euro to weaken on a trade-weighted basis. External demand is more important than the exchange rate for driving eurozone exports, but the outlook abroad has become even more uncertain.
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