Ernst & Young’s latest Eurozone Forecast is predicting a moderate economic slowdown in the bloc during 2011.
“We forecast that GDP growth will fall to 1.4 per cent in 2011 from 1.7 per cent in 2010. In 2012–14, GDP growth should increase somewhat to average 1.9 per cent over that period,” the report says.
It says the risks to the growth outlook are skewed to the downside. Financial tensions in the “peripheral” eurozone states have risen again recently, culminating in the crisis in Ireland.
“In a worst–case scenario featuring a chain of sovereign debt defaults, our modelling suggests that the eurozone could be plunged back into a deep recession,” it says.
In this context, now is not the time to tighten monetary policy, the report stresses. Instead, the European Central Bank should monitor the highly uncertain impact of fiscal tightening and developments in financial markets, and stand ready to provide more support, should current growth expectations prove too optimistic.
“If the eurozone is hit by a new crisis, the ECB should be ready to loosen monetary policy further, be it by using similar measures as in 2009 and early 2010 or by resorting to quantitative easing.”
Much of the slowdown in 2011 is accounted for by fiscal tightening, which Ernst & Young estimates will amount to more than one per cent of GDP. Across the eurozone, public sector jobs will be cut by around 150,000, it says.
“It seems unlikely that the private sector will pick up the slack. The eurozone banking sector has not yet fully recovered and, given the substantial uncertainties about the economic outlook, banks remain cautious in their lending decisions, and availability of credit is still tighter than before the crisis.
“Tight credit adds to other factors discouraging investment. Private companies have accumulated significant cash balances that could be used to purchase new equipment, but they are also still highly indebted. Here again, there are significant differences between the South, where investment is expected to be still well below pre–crisis levels in five years’ time, and the North, where investment should be back at its pre– crisis peak by 2012.”
The report highlights that faced with the prospects of stubbornly high unemployment, cuts in government outlays and, in some cases, tax increases, households will remain reluctant to spend. Private consumption is forecast to grow on average by less than one per cent per year this year and next. This implies a slower recovery in consumption than from the recessions of the 1970s and 1990s.
“Compared with the significant uncertainties about the growth outlook, the prospects for inflation pose little concern. We forecast steady inflation at around 1.5 per cent to 1.6 per cent in 2010 and 2011. At these levels, inflation poses no threat to growth and should not prevent the ECB from further monetary stimulus if growth falters.”
The Ernst & Young forecast says the European Central Bank has appeared to close the door on following the US Federal Reserve and engaging in quantitative easing to boost the economy. Instead, the ECB has intimated a desire to start exiting from its accommodative monetary stance.
“But while growth in the core eurozone economies has been stronger than expected over the last six months, the risks to the outlook mean the ECB may yet find itself having to look for ways to support demand and avoid a double–dip recession.”
It says the robust performance of the eurozone economy in the first three quarters of 2010 hides large and widening differences between countries. In the year to Q3 2010, GDP growth ranged from –3.6 per cent in Greece to +3.6 per cent in Germany. This is even before the peripheral economies will have been hit by the full strength of deficit tightening measures, it says.
“Divergent economic conditions are particularly manifest in the eurozone labour markets and are expected to persist for several years. Overall, we do not expect the number of unemployed in the eurozone to fall below 15 million before 2013. But while unemployment in the North of the eurozone is expected to begin falling from early 2011, in the South this is not forecast to happen until one year later at the earliest.”
The forecast looks at future developments in terms of three scenarios. In the optimistic scenario, economic growth picks up and the fiscal consolidation efforts by governments boost the confidence of financial markets. The positive impact on private sector investment would compensate for a drop in consumer demand. In this scenario, exports and investments support growth.
“This is not our forecast. In our scenario, we will see very slow demand growth, and slow overall economic growth, as the fiscal adjustment programs start to bite. The positive developments in the first three quarters of 2010 were, in part, the consequences of the various discretionary stimulus programmes, many of which only kicked in with some delays and of a natural bounce-back effect after the steep crisis of 2009.
“Our average projection for economic growth in 2011 is 1.4 per cent, which is lower than one would expect for this stage in the economic cycle, as private consumption and investment are still growing at relatively low rates,” it says.
Ernst & Young says this average hides a large deviation among member states. The prosperous countries in the north will generally outperform the south – or, more precisely, the eurozone core will outperform the periphery. Germany will enjoy an economic growth rate of 3.5 per cent in 2010, followed by rates of 2.1 per cent in 2011 and 1.7 per cent in 2012. Italy will grow at rates of close to one per cent in each of those years, while in Spain, growth will turn only marginally positive in 2011 before the start of a slow recovery in 2012.
“Our forecast is cautious but not alarmist. In our scenario, solvency is assured everywhere in the eurozone. The risk to the eurozone does not therefore stem from a scenario in which our forecast becomes true, but from a third, much more negative, scenario, in which growth falls below the level needed to sustain solvency in some parts of the eurozone.”
The report concludes that the risks of its forecast are tilted to the downside, and the degree of the tilt will depend predominantly on the future development of the crisis.
“If the anti-crisis policies work, we will quickly return to our baseline scenario of modest, but unspectacular, growth. If the crisis persists – even without any dramatic events such as a sovereign default – growth will suffer across the eurozone, albeit unevenly. If the crisis takes a dramatic turn for the worse, all bets are off. We would then move outside of any scenario that a forecast could conceivably capture,” it concludes.
In a separate report Ernst & Young predicts that Malta’s economic growth in 2011 will slow as the boost from public spending and net exports fades.
“Despite the Budget’s emphasis on investment, GDP growth will slow in 2011 due to weaker net export growth and the delay before rising private investment brings new capacity on stream. Stronger investment-led growth will resume in 2012,” the Malta report says.
Ernst & Young says it expects Malta’s economic growth to average 2.1 per cent in 2011, in contrast to the Maltese government’s forecast of three per cent, before accelerating towards three per cent from 2012.