RaboResearch - Economic Research

Eurozone economy: Neither icing nor a cake

Economic Comment

  • The Eurozone economy grew by 0.1% in the fourth quarter of 2019
  • France and Italy unexpectedly underperformed, contracting by respectively 0.1% and 0.3%. The French economy will likely rebound in the next quarter but we cannot rule out an Italian recession next quarter
  • For 2020 we expect growth to remain lackluster. Domestic demand will slow as the business cycle has substantially advanced, whilst the external environment will remain weak
  • Escalating trade tensions between the US and the EU are a risk to economic growth in the Eurozone

No reason for celebration

Figure 1: France’s and Italy’s economy have contracted in 2019Q4
Figure 1: France’s and Italy’s economy have contracted in 2019Q4Source: Eurostat

The Eurozone economy expanded 0.1% q-o-q in the fourth quarter of 2019, slightly below consensus expectations of 0.2% q-o-q. We will have to wait until February for the official breakdown by components of GDP growth. From the growth figures from individual member states we cannot point out an obvious component that contributed hugely to economic growth in the Eurozone. Although it looks like net exports no longer dragged down economic growth as they did in previous quarters. This obviously implies that growth of domestic demand slowed down further.

An unexpected contraction

The French economy unexpectedly shrunk by 0.1% in the fourth quarter. Whereas the retail sales and industrial production figures in the beginning of the quarter were promising, the pension protests that started in December last year have probably thrown a spanner in the works. Disruptions to ports and railways, let alone the impact on sentiment, have dragged down economic growth. A preliminary breakdown shows that household spending growth slowed from 0.4% in Q3 to 0.2% in Q4. Fixed capital formation growth slowed to 0.3%. Both exports and imports shrunk as well, resulting in a net neutral contribution to GDP growth of net exports. The largest impact was from a decrease in inventories that shaved of 0.4% of GDP growth. Since inventory volumes will likely return to a previous level as soon as the unrest surrounding the protests has settled, we expect that the lower growth in Q4 will be offset by a slightly higher growth in 2020Q1 and 2020Q2, assuming that labor tension ebb over the course of the year.

The Italian economy contracted by 0.3% compared to the third quarter. The industry sector contracted, while the services sector was stagnant. Looking at expenditure components, domestic demand pulled down growth, while net exports contributed positively, likely due to weak or contracting import growth. That’s the opposite picture of the previous quarter. Looking forward, the first quarter of this year will likely be better than the final quarter of last year, but a technical recession is a real possibility in Italy.

Little change expected going forward

Looking forward, PMIs and sentiment indicators suggest this quarter might be better than the previous one, but a significant acceleration is unlikely. For the year as a whole, we expect the Eurozone economy to grow at a similar pace as last year’s: we forecast growth of (slightly under) 1.0% for this year and 0.8% next year, after 1.2% in 2019. Growth will primarily be driven by domestic demand. Domestic demand is supported by a strong labor market, real wage growth and high consumer confidence, albeit at a slightly deteriorating pace going forward. Given the tight labor market – unemployment reached an all-time low in December - employment growth will expectedly continue to slow, for example (figure 3). Meanwhile, foreign demand will continue to be hampered by weak demand from emerging Asia. Weak Asian demand can be explained by the US-China trade war, a slowdown of the Chinese economy set in motion already prior to the trade war and specific structural problems in other emerging Asian markets. On top of that, we forecast a recession in the US end-2020, which will hurt the entire global economy. The recently signed phase-one deal slightly eases tensions for the time-being, but does not materially improve our outlook. Especially not since we expect tensions to re-escalate in the course of 2020. Ongoing uncertainty and a harder-than-foreseen Brexit end-2020 could also turn out to be a growth-dampener in 2020/2021.

Figure 2: Sentiment decline bottoming out
Figure 2: Sentiment decline bottoming outSource: Eurostat
Figure 3: Employment growth set to slow further
Figure 3: Employment growth set to slow furtherSource: Eurostat

Transatlantic trade tensions

Rising tensions between the US and the EU are a risk for the Eurozone economy. The dispute over China politics, defense spending, the trade balance, EU agriculture policy, the French digital service tax and the upcoming EU carbon border tax has led the US to warn the EU that it may hike tariffs on its export goods if it doesn’t give in to US demands. The EU has warned the US it would retaliate, but is trying to ease tensions at the same time. President Trump’s most feared threat is a hike of import tariffs on European cars to 25%. Such a hike could push the German and Italian economy into recession. At this moment, we do not expect the US to make good on this threat, but with the phase 1 deal between the US and China signed, president Trump can shift his focus to the EU. Accordingly, it is very likely Trump will intensify his threats to hike tariffs. Because of the large potential impact, the EU is determined to ease the tensions but will strike back if necessary, which would bring a transatlantic trade war closer.


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