Tuesday 31/03/2020

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Eurozone cyclical recovery continues

Chief Economist

Economic activity in the eurozone is gaining pace. Confidence among firms and consumers is high which points to more positive economic news in the months ahead. Inflation, on the other hand, remains subdued. Against this background, the ECB is shifting its tone away from stimulus but only so in a gradual and cautious way.

Going by the most recent evolution of confidence indicators, economic activity looks set to easily surpass the 2%-level (on an annualized basis), more or less double the estimates of eurozone potential growth (around 1%). This implies that the large negative output gap is gradually closing and that unemployment (currently at 9.3%) is coming down significantly from high levels. Therefore, it is only logic that the ECB has struck a more positive tone in recent weeks. More observers are now arguing in favor of tighter monetary policy. However, there’s no need to fully hit the brakes at this point in time. Underlying inflation and wage growth remain very subdued for the time being. Moreover, significant economic differences between countries still exist. Last but not least, with premature policy tightening in 2008, 2011 and 2013-2014 fresh in the memory, the ECB will want to avoid moving too fast.

While this recovery is more solid and more broad-based than anything we have witnessed over the last couple of years, in a way it is also the easiest part. The tailwinds stemming from low interest rates, low commodity prices, low exchange rate, the end of austerity and a more synchronized global recovery are very helpful but also likely to fade over time. Encouragingly, structural labour market reforms are bearing fruit and there is more hope that Merkel and Macron can bring about a more positive vibe throughout Europe. If this is followed by concrete action on the institutional front and more public and private investment, the structural issues related to the ageing of the population and slowing productivity growth could prove somewhat less hard to bite. Importantly, higher interest rates, in return, imply there would be more room for monetary policy easing when the next recession hits further down the road.