Against the tide: Greece – the joker in the pack
The eurozone recovery looks increasingly secure but the low growth rate is still a big cause for concern.
I’m continuing my theme from last month that, modestly and gradually, the European Central Bank is finally delivering for both households and corporates in Europe, as the effects of earlier rate cuts and the weaker euro begin to bear fruit.
The ECB’s negative deposit rate and the onset of quantitative easing are providing further improvement of credit channels. There are clear incentives for banks to use the increased liquidity to make loans or buy positive yielding assets – including equities – both within the eurozone and (importantly) outside, which will maintain downward pressure on the single currency.
The effect on confidence is potentially virtuous, as increasing household spending feeds through to corporate bottom lines, while exporters begin to reap the rewards of a more competitive currency.
Eurozone production data has failed to keep pace with buoyant consumer numbers since the start of the year, taking some shine off the improving growth story.
Made of sand
It wouldn’t be the first time that glimmers of a regional recovery turn out to be made of sand. But it is the first time since the onset of the global financial crisis that the policy tools needed to deal with setbacks are actually in place. Monetary policy has turned expansionary. And the external backdrop is sufficiently supportive to alleviate the risks of any soft patch. More simply, the effect of lower oil prices and a weaker euro on Europe’s demand far outweigh any pressures from a slowing China or Russia.
Although unemployment across the region as a whole is elevated, the headline jobless rate has been falling. More importantly, employment is growing. Although the labour market recovery is in its infancy, the effect on confidence should still be big.
This effect is being magnified by the rise in real disposable incomes that falling inflation has delivered. It is clear to see in the retail sales figures, which have moved higher across the region. While consumer spending might be picking up off a low base, growth rates for both headline and core (ex-food and fuel) retail sales are back at their pre-crisis highs.
While the growth rates of outstanding debt are only just turning positive, demand for new credit has been robust. Mortgage lending has led the way but consumer credit is also rising strongly, suggesting a sustainable improvement in confidence.
Corporates are also getting back in the game too. Demand for fixed investment might have dropped back in the most recent ECB bank lending survey but the overall level is still commensurate with previous periods of positive investment growth. In sum, the eurozone recovery thesis is gaining credence, with improvements seen across a broad snapshot of both the higher- and lower-frequency macro numbers.
This all increases my conviction in the sustainability of this turnaround. However, it’s important to measure this recovery against a level of growth needed to cut into the eurozone’s massive output gap and return inflation to the ECB’s targeted 2%.
It took the US nearly five years to get the headline unemployment rate back to within touching distance of normal. The impact of the depression on the eurozone’s labour market has been far more damaging, evident in the punishing levels of youth and long-term unemployment. Full normalisation could take another decade.
Structural reforms have been embraced in a rather uneven fashion too, those subject to bailout sticks proving far more obliging patients. France and Italy, by contrast, focused on foot dragging, depressing growth potential. So while short-term activity in the eurozone should surprise on the topside, the mid-term outlook still points to a growth rate of only around 1.5%. That’s a good one percentage point below that of the US and being achieved with the ECB in full-blown QE mode.
The joker in the pack for rising confidence in a eurozone economic recovery is Greece. Although Greece constitutes only 2% of eurozone GDP (a full one percentage point decline since 2010), uncertainty over the possibility of a Greek default on its euro loans and an eventual exit from the eurozone will continue to weigh down on the euro.
It’s not so much any contagious impact of Grexit on the eurozone recovery, but the setting of a precedent: that euro membership is not irreversible. Ironically, Greece may exit just at the time when the eurozone recovers and all boats start to rise on the tide of growth.