The softening of the European sentiment indices (ESI) since the turn of the year signal the eurozone has entered a soft growth patch and the critical question is how big will be the slowdown and whether it is the beginning of a major downturn. Historically, the peak of ESI has implied a real GDP growth moderation of 1p.p. or more. In our view, this time it may prove more moderate, of a magnitude of 0.4p.p., but it will come at the cost of a much economic and financial correction later on.
These are the factors that make us sceptical about a big economic and financial downturn in the very near term (i.e. a 2p.p. or more real GDP growth slowdown). We don’t think the Trump trade policy strategy wants to trigger a global downturn, but aims to set the conditions for a narrowing of the US external deficit of USD100-200bn within few years. In fact, we continue to think that consensus projections underestimate the US growth outlook for 2019. In the eurozone, capacity constraints and profit developments suggest there is a case, and there is the funding, for improving investment growth. Indebtedness in the eurozone is high, but not much above what it used to be back in 2008 and to some extent the overall balance sheet position is stronger. Central banks around the world, including the ECB, do not appear genuinely keen to spoil the party, in fact we may see lower real policy rates going forward than in recent years. Last, but not least, the European parliamentary elections in June 2019 are a critical test for the future of the EU, providing one more reason to expect monetary policy to be accommodative.
In our view, the next downturn will be the result of a protracted disappointment in consumption growth relative to market expectations, notwithstanding the falling unemployment rate. We suspect this process will be slow: in the age of big data weaker than expected sales can be matched with small price cuts to revive demand. However, this is just going to be a temporary patch, as fundamentally as consumers need higher incomes or much cheaper services.
The “problem” in the real economy in our view is the growing inequality of profit in the corporate sector and related to the fact that overall inflation, in our view, is higher than we can capture in the published official estimates.
The appropriate policy response to these changes will need to come from a change in fiscal strategy, an improvement in industrial strategies, and greater regulatory scrutiny of mega-companies across sectors. In this respect, the upcoming negotiations for the EU Multiannual Financial Framework for 2021-27 should be monitored closely, in our view. Don’t expect low interest rates to heal the economy over time, in fact smaller monetary tightening than previous cycles should suffice to trigger a recession.
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