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Economic growth is expected to remain subdued, due to weak external demand and low business confidence, which weighs on private investment. Moderate support to economic activity will come from private consumption, underpinned by a robust labour market, with unemployment declining slightly further and wage growth firming up modestly. Core inflation will pick up only gradually from low levels. Monetary policy is set to remain very accommodative and a slightly expansionary fiscal stance is expected. The large external surplus will decline very slightly.
Delaying monetary policy normalisation until the economy is on course to attain the inflation objective is appropriate. As investment and growth potential still display the scars from the crisis, a combined fiscal and structural policy effort is called for. Countries with low public debt should expand public investment, which would address infrastructure gaps and generate positive spillovers across the euro area. All countries should pursue structural reforms to make product markets more competitive, especially in services and network industries. Faster advances in completing the banking union and in developing common fiscal tools would reinforce the capacity of the euro area to resist the next crisis.
Growth has slowed down substantially
The euro area economy has slowed down markedly since mid-2018. Weaker external demand, especially from some emerging-market economies, and persistent trade tensions have weighed on export growth. Investment has weakened as well, with substantial destocking in the final quarter of 2018, and in some countries activity was further hampered by one-off factors. A reversal of the one-off factors contributed to more vigorous growth in the first quarter of 2019, but underlying weakness persists. Indeed, recent indicators point to sharp declines in new export orders and investment goods production, and to weakening business confidence, especially in manufacturing. The whole euro area has been affected, with a sharp decline in intra-area trade, likely reflecting highly-integrated supply chains. However, impacts have been asymmetric across countries, with Germany and Italy hit hardest, in line with their strong reliance on manufacturing and, especially in the German case, high trade openness and exposure to the car industry, in which one-off events were felt strongly.
1. Nominal wages per employee.
2. Harmonised consumer price indices, net of energy and food products for core inflation.
Source: OECD Economic Outlook 105 database.
1. Volume, deflated by the GDP deflator; private investment is obtained as gross fixed capital formation of the total economy minus public investment (government fixed capital formation, in the appropriation account).
Source: OECD Economic Outlook 105 database.
Against this backdrop, private consumption has displayed some resilience, as have confidence indicators in services. This largely reflects a robust labour market, with unemployment declining further in most countries and some mild acceleration in wages. Nonetheless, the pass-through to prices has so far been limited, with core inflation still hovering at around 1%.
Growth and resilience to future crises need to increase
Monetary conditions will remain very accommodative, which is appropriate, given the protracted weakness of core inflation and the need to support internal demand and minimise risks of instability in financial markets. Net asset purchases were brought to an end by the ECB in December, as planned, but continued reinvestment of proceeds from maturing assets will help to keep long-term interest rates at low levels. According to the ECB, policy rates are to remain unchanged at least through the end of 2019. A new series of quarterly targeted long-term refinancing operations (TLTRO) has been introduced, starting in September 2019, which is welcome. The first increase of the main refinancing rate is expected to only take place in the fourth quarter of 2020. Macroprudential, housing and tax policies should be used at national level to reduce the build-up of housing risks.
The aggregate euro area fiscal stance is expected to be slightly expansionary in 2019-20, by about ¼ percentage point of potential GDP in each year. Moderate fiscal loosening is observed across countries with very different budgetary room for manoeuvre, and often comprises measures to support households’ disposable income. While this support is welcome, it does little to revive the area’s subdued growth potential and still depressed investment levels. Taking advantage of historically low interest rates, there is a case for additional stimulus in the form of a combined increase in public investment by countries with low public debt and renewed structural reform efforts in all countries. Increased public investment would help to address national investment needs, generate positive spillovers for other euro area countries, and ease the introduction of structural reforms.
Combined policy efforts are also needed to complete the economic and monetary union. All countries need to further liberalise product markets, especially in services and network sectors, to deepen the single market and reap the ensuing productivity gains. Progress in establishing a banking union through common deposit insurance and a common fiscal backstop to the Single Resolution Fund would increase resilience to future crises, inter alia by fostering financial market integration. An acceleration of the resolution of remaining non-performing loans, which are still high in some countries, would also favour financial integration and boost credit and investment. Creating a common fiscal capacity for the euro area can help to smooth economic shocks and buttress the euro area when the next crisis hits. In parallel, adopting simpler fiscal rules focussing on expenditure growth anchored to a debt ratio target would improve fiscal credibility and effectiveness.
Growth is projected to remain subdued
Growth is projected to remain modest at below 1.5%. Policy uncertainty and trade tensions will continue to hamper exports and private investment, thus contributing to very modest productivity growth. Some support to activity, albeit on a limited scale, is expected from private consumption and public spending, and moderate employment growth will make joblessness decline slightly. In line with only moderate internal demand growth, core inflation is projected to pick up slowly and the euro area’s large current account surplus will fall only marginally.
Given strong participation of euro area companies in global value chains, additional escalation of global trade tensions would exert downward pressure on exports and investment. Pressure would also stem from a disorderly Brexit, with countries with the strongest trade links to the United Kingdom hit hardest. A stronger-than-expected slowdown in emerging-market economies would depress external demand and could induce financial instability. On the upside, combined actions to increase public investment and implement structural reforms in product markets would help the euro area to recover from long-standing anaemic productivity growth.
