FEATURE Eurozone Slowing economic dynamics while Brexit casts its shadows Alexander Börsch
The economic recovery continues, albeit weaker than before, driven by consumer demand and labor market performance, even though risks are aplenty. Still growing, but at a lower speed Good news first. The eurozone economy has entered its sixth year of uninterrupted growth. The bad news is that the growth dynamics have slowed down compared to 2017. In the third and fourth quarter of 2018, the eurozone economy grew by 0.2 percent, half as fast as in the first half of the year. Among the large eurozone countries, Spain still shows the strongest performance, followed by France. While the German economy is projected to have grown slightly in the fourth quarter after it contracted in the third, Italy entered a technical recession. 1 In Germany, the weakness in the third quarter was due to a drop in automotive production in response to new registration regulations. Overall, the eurozone is expected to have grown by 1.9 percent in 2018. 2 The recovery continues to be demand-driven. Foreign trade made a negative contribution as imports increased and exports declined. Consumer demand and corporate investments developed solidly, although at a slower pace (figure 1). Labor markets: Better than ever While exports and growth show significant signs of weakness, the eurozone s labor market is a bright spot. The eurozone has reached the highest employment level in its history, while the unemployment level is down to 7.9 percent (figure 2). 3 Unemployment has been on a slow but steady decline since 2014, but wages have stayed largely flat. This seems to be changing as wage growth picked up recently and reached 2.5 percent in autumn, the highest value since late 2008. 4 Together with growing employment, this will likely fuel private consumption. FIGURE 1 Domestic demand has a dominant effect on eurozone growth Real GDP growth and its main components (YoY, %) Net exports Domestic demand Real GDP growth 4% 3% 3% 2% 2% 1% 1% 0% -1% -1% -2% Mar 2016 May 2016 Jul 2016 Sep 2016 Nov 2016 Jan 2017 Mar 2017 May 2017 Jul 2017 Sep 2017 Nov 2017 Jan 2018 Mar 2018 May 2018 Jul 2018 Sep 2018 Source: Eurostat. 2
Sentiment: Heading south Despite the good labor market situation, business and consumer sentiment has been worsening since end 2018. The development of several prominent early indicators underlines this. The European Commission s Economic Sentiment Index decreased markedly in December the lower confidence level runs through all economic segments, ranging from industry and services to construction and consumers. 5 A similar message comes from the Purchasing Managers Index (PMI), which dropped to 50.7 points in January. 6 Not only is this a five-year low, but the PMI is now very close to the critical value of 50 values above 50 indicate accelerating economic activity and those below 50 indicate decreasing economic activity. There are several conceivable factors for the deteriorating sentiment, some of them countryspecific. The trade war between the United States and China contributes to uncertainty in the export-oriented economies of the eurozone, as do political protests in France or the debt situation in the eurozone in the context of lower economic growth. 7 Whether these factors are only temporary or whether the worsening sentiment further slows down the recovery will be the crucial question in the coming months. In this context, probably the biggest risk comes from uncertainties surrounding Brexit. The impact of Brexit on the eurozone Brexit is supposed to take place on March 29, when the two-year period after the United Kingdom declared its exit under Article 50 expires. In January, the British Parliament rejected the withdrawal agreement between the United Kingdom and the European Union, which foresees a transition period until the end of 2020 to negotiate a new trade and political partnership. 8 In principle, there are still many options on the table, ranging from postponing Brexit to a new referendum to snap elections to a revised withdrawal agreement. Nevertheless, time is running out and a hard Brexit an exit without an agreement remains the default option in the absence of a new FIGURE 2 Employment increased to a new high in the eurozone Employed persons (right-hand scale), unemployment rate (%, left-hand scale), and nominal wage growth (%, left-hand scale) Employed people (rhs, 1.000) Unemployment rate (lhs, %) Nominal wage growth (lhs, % YoY) 14% 12% 10% 8% 6% 4% 2% 0% 165,000 160,000 155,000 150,000 145,000 140,000 135,000 130,000 125,000 120,000 Jun-98 Mar-99 Dec-99 Sep-00 Jun-01 Mar-02 Dec-02 Sep-03 Jun-04 Mar-05 Dec-05 Sep-06 Jun-07 Mar-08 Dec-08 Sep-09 Jun-10 Mar-11 Dec-11 Sep-12 Jun-13 Mar-14 Dec-14 Sep-15 Jun-16 Mar-17 Dec-17 Sep-18 Sources: Eurostat, European Central Bank. 3
FIGURE 3 The United Kingdom's trade volume with other countries: In the short term, a no-deal Brexit will have an impact on trade Trade volume in absolute terms (US$ billion, 2017) Germany Netherlands France Belgium Italy Ireland Spain Poland 19.2 Sweden 17.2 Czech Rep. 13.1 35.9 34.3 38.7 55.9 67.4 66.2 136.2 Source: UN Comtrade. plan. The disorderly exit of the United Kingdom would not leave the eurozone economies untouched. The macroeconomic impacts on the eurozone are unevenly distributed. Model-based simulations point to GDP losses between 0.1 percent (Austria) and 1.4 percent (Ireland) in the case of a no-deal Brexit. France, Germany, Italy, and Spain would face GDP losses of 0.2 percent, according to these calculations. 9 The main channel through which a no-deal Brexit would affect Europe in the short term is trade. In relative terms, Ireland has the closest links and the biggest exposure to the UK economy. In absolute terms, however, the UK-Germany trade volume is the highest, followed by UK-Netherlands, UK- France, and UK-Belgium trade volumes (figure 3). In addition to the direct effects of a no-deal Brexit, there are also factors that could have indirect macroeconomic effects on eurozone economies, but they are hard to model. In particular, the consequences of supply chain interruptions as well as the effects of uncertainty regarding tax regulations, product regulations, and financial market reactions could have immediate effects on European companies. Even though there is no shortage of political risks, Brexit is the biggest short-term risk for the eurozone with effects that are difficult to foresee. However, despite these risks and the worsening sentiment, the domestic drivers of the eurozone s recovery labor market performance and domestic demand remain intact, while wages are finally rising. This suggests that if and that is a big if the political risks do not materialize and stop dragging company sentiment, there is no reason why the eurozone recovery should not continue 4
Endnotes 1. Eurostat, GDP up by 0.2% in the euro area and by 0.3% in the EU28, press release, January 31, 2019. 2. European Central Bank, December 2018: Eurosystem staff macroeconomic projections for the euro area, December 13, 2018. 3. Eurostat, Euro area unemployment at 7.9%, press release, January 9, 2019. 4. European Central Bank, Compensation per employee, Statistical Data Warehouse, accessed February 7, 2019. 5. European Commission, Economic sentiment decreases markedly in both the euro area and EU, January 2019. 6. IHS Markit, IHS Markit flash eurozone PMI, press release, January 24, 2019. 7. International Monetary Fund, World Economic Outlook update, January 2019. 8. UK Parliament, Government loses meaningful vote in the Commons, January 15, 2019. 9. Deloitte Brexit Briefing 9, Wie kann es kurz- und mittelfristig weitergehen?, January 2019. About the author ALEXANDER BÖRSCH is the chief economist and head of research at Deloitte Germany. Before joining Deloitte, he worked as senior economist in the investment management and management consulting industries. He is the author of numerous publications on topics such as the European economy, economic trends, digital economy, Brexit, and competitiveness of companies, cities, and nations. He holds a PhD from the European University Institute and was a visiting researcher at the London School of Economics, Warwick University, and INSEAD. Contact Alexander Börsch Deloitte & Touche GmbH Germany +49 (0) 89290368689 aboersch@deloitte.de 5
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