Although the eurozone faces a challenging year with large amounts of public and private sector debt yet to be refinanced, tight credit conditions, further fiscal austerity and more job losses, Ernst & Young’s Eurozone Spring Forecast is predicting a slow return to growth in 2013.
Amongst the larger economies, only in Germany is investment spending likely to grow meaningfully but not until the second half of the year
However, the forecast points out that that the European Central Bank has to continue to play a central role by being prepared to cut interest rates further and purchasing government bonds in peripheral countries.
“With a default on Greek sovereign debt negotiated and a second bailout agreed, and assuming that policy-makers continue to keep up the momentum by putting a credible firewall around Spain and Italy, EEF is forecasting a mild recessionary fall in eurozone GDP of 0.5 per cent this year, with nine of the 17 eurozone members economies set to contract. However EEF expects eurozone GDP to grow by about one per cent in 2013 before picking up to two per cent a year in 2015-16,” the report says.
GDP growth in Malta is forecast at 0.9 per cent for 2012 and 1.5 per cent for 2013.
“For Malta we forecast GDP growth of 0.9 per cent in 2012, with a slight pickup to 1.5 per cent in 2013 as exports start to recover, but a broader-based recovery will be delayed until 2014 – 15, when growth is expected to rise toward three per cent,” it says.
Marie Diron, senior economic adviser to the Ernst & Young Eurozone Forecast said: “Although the recovery from recession is likely to be the slowest in Europe in the last 40 years the actions taken by the authorities over the last few months, particularly the introduction of the long-term refinancing operations by the ECB, have created conditions where it is possible to now see light at the end of the tunnel even if actual recovery is still some way off. These policy efforts have to be rigorously maintained and even reinforced at a eurozone and national level to ensure we don’t lose momentum.”
Mark Otty, Ernst & Young Area Managing Partner for Europe, Middle East, India and Africa said: “Despite the turmoil, the majority of large businesses across Europe remain in relatively good financial shape as the past two years have seen them making efficiency savings, improving profit margins and adding cash to their balance sheets. If they have some confidence that stability is returning we could see investment and job creation follow.”
The report highlights that the main constraints to eurozone growth this year will stem from fiscal consolidation, which it estimates will amount to more than one per cent of GDP, and tight credit. Despite the introduction of the long-term refinancing operations which has boosted financial markets and ensured that the prospect of a banking credit crisis has receded, the forecast says that the latest data indicates that much of the liquidity provided has not yet been lent on into the wider economy.
Ms Diron said: “Eurozone banks are still facing difficult financing conditions, at a time when they need to achieve higher capital ratios. As long as banks are not passing on the liquidity borrowed from the ECB to businesses and households, credit conditions will remain tight dampening both investment and consumption. Indeed, there is a risk that credit constraints and fiscal austerity are more severe and protracted than we currently envisage; in this scenario, the eurozone would experience a deeper recession.”
Ernst & Young says that in response to tighter financing conditions, an increase in spare capacity and weaker domestic demand, businesses are likely to scale back investment spending.
“Spanish and Italian firms are forecast to cut capital spending by five per cent or more in 2012, while in France and Benelux investment will remain flat or edge down slightly. Amongst the larger economies, only in Germany is investment spending likely to grow meaningfully but not until the second half of the year,” it says.
The report says that despite a moderation in inflation this year (assuming no further rise in oil prices), consumer spending is also likely to be reduced reflecting an uncertain external outlook and deepening fiscal austerity although perhaps by less than might be expected.
“At the eurozone level, EEF predicts that growth in consumer spending is likely to be negative at -0.7 per cent. However, German consumers are likely to increase spending by around one per cent, while French household spending will remain broadly flat.
“This outlook for business investment and consumer spending means job creation is set to weaken in most eurozone economies. With Germany again set to be one of the few exceptions, EEF forecasts unemployment rates to rise across the eurozone in 2012 peaking at 18.2 million at the turn of the year, although given the relatively strong balance sheets of many European corporates this trend could be quickly reversed if confidence begins to return,” the report points out.
The forecast says the European Central Bank will continue to play a critical role in 2012 by providing extensive support to the eurozone economy. Should the economic environment deteriorate, Ernst & Young believes this should include lowering interest rates further to 0.5 per cent and stepping up purchases of government bonds to facilitate debt refinancing by peripheral countries at affordable interest rates. Without action, there is a risk of a series of disorderly defaults among weaker countries that could threaten the future of the eurozone.
Ms Diron said: “Although the risk of a breakup of the eurozone has fallen back since late last year thanks to the agreements on Greece and the involvement of the ECB it doesn’t mean that we have yet emerged from the crisis. At best, 2012 will be a difficult year for governments, businesses and households alike. Even the weak recovery forecast for next year should not be taken for granted given the substantial problems the region faces over the next 12 months.”
The forecast is optimistic, however, that the eurozone policy community will tackle these challenges successfully and avoid any permanent structural damage to the currency. Nevertheless, given the impact of the crisis on banks’ balance sheets, and the weakness of public finances in many countries, the recovery will be much slower than after previous downturns, it stresses.
The scale of current crisis could also be the trigger for eurozone-wide reforms that would have otherwise been considered too difficult to implement. Real structural change to encourage medium and long term growth to enable the region to compete with developing markets is in many cases long overdue, the report says.
Mr Otty said: “The eurozone needs to do more to improve the economic outlook beyond 2013. Tackling rigidities in the labour market, improving the quality of institutions in some countries, taking difficult decisions on the care of aging populations, and encouraging a single market for services would all go a long way toward improving long-term growth prospects. By taking these steps now, eurozone governments would also take a big step towards easing the current crisis and help prevent the next.”