The Eurozone failed to pull off a growth rebound in the second quarter and is now in a difficult position, compounded by the fact that, in our view, the trade war between the United States and China is destined to prove more serious and lasting than expected. The European economy is more foreign trade oriented than other advanced economies, which means it could come under pressure if global trade weakens further.
Although the GDP of some of the larger member states has risen, weak growth in Italy and France weighed on the overall figure and Austria and Spain also recorded slowdowns. In Germany, the reading improved compared to the first three months of the year, but industrial new orders decreased, signaling bleak prospects for the contribution of net exports to GDP growth.
Figure 1: GDP growth Q1 vs Q2
In the light of these considerations, we cut our 2018 Eurozone GDP growth estimates to 2% from 2,4% previously. This is our second downgrade consecutive, mainly attributable to expectations of an intensification of the trade wars and the consequent impact on the external performance of the Eurozone. 2019 should follow a similar trajectory: domestic demand should hold up well, but ongoing trade tensions will curb external demand, which is why we have revised our forecasts down from 2,1% to 1,7%.
In terms of monetary policy, the European Central Bank has returned to wait-and-see mode since the last update of the forward guidance on June. In particular, the Eurotower is monitoring two crucial risks: the first concerns the impact that the worsening external scenario will have on the Eurozone economy, while the second is represented by the political situation in Italy.
The Italian government will formulate a budget law proposal in the coming months, which would appear to be oriented towards a reduced fiscal stimulus package. However, there is a risk that the populist government will start a battle against the European Commission. This second eventuality could trigger what we have hypothesized as the “Scenario of an Italian debt crisis”. This theoretical exercise predicts a drastic increase in the yields of Italian government bonds, with the consequent widening of the spread and the depreciation of the euro. Eurozone growth would also be seriously hurt in this scenario. Such a situation could only be resolved by the ECB reinstating QE and installing a technical PM.
That said, our baseline scenario is for the ECB to continue on its announced path and end QE at the end of this year, keeping rates unchanged until summer 2019.
Finally, The Brexit negotiations also weigh on the growth prospects of the Eurozone, which are coming to a head and are highlighting all the risks related to the possible outcome. GDP grew in the second quarter, but the overall figure concealed weaknesses in terms of demand and the contribution of net trade. In a context where great uncertainty persists, we have therefore also cut the UK GDP estimates for this year from 1,4% to 1,2% and for 2019 from 1,6% to 1,3 %, as we estimate that weaknesses will continue post-Brexit as well.
