Forecasts tend to be very pro-cyclical and are usually unable to detect inflexion points, especially given the extent to which the perception of those who put them together is often coloured by the prevailing psychology. Periods of euphoria translate into highly optimistic growth expectations, with the temptation to stretch them to extremes, while a mood of prevailing pessimism results in a forecasting race to the bottom driven by contagious fear. This is why no one is currently sticking their neck out and forecasting a more decisive recovery in the eurozone. The best way to avoid being accused of naive optimism is to extrapolate out from recent trends while pointing out the downside risks.
And so, in the space of just a few months, forecasters have sharply downgraded their 2019 eurozone growth forecasts. Last December, the consensus was for average growth of 1.6%, with forecasts ranging from 1.2% to 1.9%. In March, the average growth forecast had fallen to only 1.2%, with estimates falling within a narrower range of 0.9-1.4%.
International institutions are no different: the IMF, the OECD, the European Commission and the ECB, having collectively adopted an optimistic stance a few months ago, anticipating growth of 1.8-1.9%, have significantly cut their forecasts, which now point to growth of around 1%. Although a majority of forecasters are betting on an upturn in activity in the second half of the year, the very slight improvement expected in 2020 shows just how cautious they are.
Paradoxically, markets have gone the other way. After last autumn’s mini-crash, they have regained momentum and wiped out their losses within the space of a few months. The softer tone adopted by central banks, which have suspended or deferred any further hardening of monetary conditions, has naturally given markets a boost. From their perspective, however, fears over global growth have also faded, which should cause the economic horizon to brighten. Trade tensions have eased, a Chinese recovery is around the corner and the Brexit saga has been put on hold: all good reasons to revive animal spirits – for a while, at least – under the watchful eye of central banks.
While these conflicting messages will surely be put to the test, it is not unreasonable to suggest that renewed confidence could, by virtue of its self-fulfilling nature, act as a fairly powerful driver of growth. An external economic bright spot would undoubtedly give the European economy a nudge, especially in Germany, an outward-looking country hit particularly hard by the global slowdown. This is especially true given that the tricky switch to new vehicle standards, which has disrupted production lines and made it harder to market new models, could, once digested, leave room for a recovery in the sector. Intra-regional trade, weakened by sluggish growth in major European economies, could act as a catalyst if activity bounces back. And all this in an environment where, provided confidence returns, hitherto resilient domestic demand could strengthen. Firstly, declining inflation is restoring purchasing power to households. Secondly, the virtuous cycle of job creation, revenue generation and consumption shows no sign of flagging, proving that the cycle is not over yet, and should act as an effective transmission channel if the expected improvement in the business climate materialises. And lastly, fiscal policy has taken a more expansionary turn in many European countries, providing additional support for activity alongside extremely flexible financing conditions. Protected by these more favourable conditions, the eurozone could return to more vigorous growth, with confidence and economic activity feeding off each other, surprising analysts to the upside.
However, this scenario is entirely dependent on both external and internal political developments.
While forecasters might be overly pessimistic, markets have no doubt jumped the gun by relegating political risks to the sidelines; Donald Trump’s fickleness could scupper US trade talks with China or poison relations with European allies; the threat of a hard Brexit still lingers, with the deadline merely pushed back to 31 October; and the outcome of the European elections in May could confirm a breakthrough by eurosceptic parties, potentially interfering with the European Union’s workings and impairing its cohesion.
In the end, betting on renewed growth means believing that there will be political happy endings to boost confidence – an essential ingredient for the smooth functioning of economies.
Isabelle JOB-BAZILLE, Directeur des Etudes Economiques Groupe