Bruised euro-zone economy stumbles on after its 2018 beating

The euro-zone economy is down but not out after a year battered by freezing weather, trade wars, budget disputes and car trouble.

The exuberance of 2017 — when the bloc enjoyed a brief “euroboom” — has given way to slowing momentum and an onslaught of bad news. Germany’s supposed powerhouse economy contracted over the summer, and Italy is not only shrinking but also reviving memories of the regional debt crisis. European automakers are wondering if they’re next to be targeted by US import tariffs.

Purchasing managers surveys show the deterioration continuing. Italy is close to a triple-dip recession, and its benchmark stock index has dropped 12% in six months. The Stoxx Europe 600 is down 10%. The S&P 500’s decline is half that.

That’s all left economists wondering how bad things can get. Barring a shock though, the answer for most is that the signs point to continued — if low-level — expansion.

The outside chance of a slump has increased but “growth is likely to remain decent,” said Bert Colijn, an economist at ING. “Are we getting toward the end of the cycle? The end, no. But more late-cycle.”

That’s still inconvenient for the European Central Bank as it prepares to halt its bond-buying program, a key step toward removing its crisis-era stimulus. Policy makers will meet Thursday, when new economic projections will reveal to what extent they see the current bout of downbeat data dragging on.

Traders have already adjusted their pricing and now see no interest-rate increase at all next year.

Rates

Other central banks are also shifting gear. Federal Reserve Chairman Jerome Powell has turned slightly more dovish recently, casting doubt on the pace of US rate increases next year. The Bank of England is on hold as it — and the UK — await Brexit.

ECB policy makers have kept a cautiously upbeat tone, saying growth has returned to a more sustainable pace and citing positives such as falling unemployment, wage growth that is starting to pick up, and solid domestic demand. They note that sentiment indicators are still above their long-term averages.

What our economists say…

“We expect Draghi to emphasise that the PMIs remain consistent with ongoing economic expansion, that the labor market has been healing and that pay growth is beginning to firm. We don’t expect any change to the description of the balance of risks to the forecast — to do so would be to lend credence to market pricing.”– Jamie Murray, Bloomberg Economics. 

The bloc’s Achilles heel is that it’s relatively highly exposed to foreign trade, so global turbulence that hurts exports can be more damaging. China, the world’s second-biggest economy and a key destination for euro-zone exports, is in the throes of a slowdown, with third-quarter momentum the weakest in almost a decade.

Nevertheless, growth in the bloc is still set to run above its long-term potential. Bloomberg Economics forecasts stronger pay gains ahead because slack in the economy has “largely been taken up already.” An apparent easing of US-China trade tensions could provide more upside.

“The best guess is that growth will be very close to the trend” despite the trade fallout, said Aline Schuiling, an economist at ABN Amro. “The domestic side of the economy will continue to grow robustly.”

L.P