It seemed just like yesterday when many economic analysts were predicting that the euro area would sooner or later break up and the single currency discarded by some eurozone members. Last year has proven the doom and gloom forecasters entirely wrong. But there is still a risk that the eurozone will eventually face severe turmoil.
In 2017, after years of financial crisis, the eurozone recorded the highest annual growth for more than a decade. Many now expect the European Central Bank will start withdrawing the support measures by reducing the amount of government and corporate debt that it buys and by beginning to hike interest rates.
With an annual growth of rate of 2.5 per cent in 2017, the eurozone not only significantly improved on the previous year’s 1.8 per cent but even exceeded the 2.3 per cent registered by the US economy. It seems that all eurozone member states recorded satisfactory growth, even if Italy still has to publish its final 2017 growth figures. A European Commission poll of economic sentiment indicates that confidence levels remain high for 2018.
The euro has appreciated by four per cent against the US dollar in January 2018 following a remarkable year in 2017. Only a few months ago many were forecasting parity between the euro and the US dollar. Today the euro is worth about US$1.25.
Some of this change in fortunes is due to the decisions taken by Eurozone countries. In France, President Macron approved tax breaks for entrepreneurs and investors and promoted labour reform intended to make the jobs market more responsive to today’s business needs. Fredrick Ducrozet, the senior Europe economist at Pictet Wealth Management, an asset manager, says: “After years of constraints weighing down on companies, we are starting to see the animal spirits reawakening. This should continue.” The appetite for risk-taking has slowly but surely returned in Europe.
There are probably some hidden risks that may prove that the eurozone’s happy days may not last for long
But there are probably some hidden risks that may prove that the eurozone’s happy days may not last for long. The victory of Emmanuel Macron in France gave the eurozone some respite from the wave of populism that threatened to disrupt effective governance in some countries. However, in a few weeks’ time, the Italian elections will show whether this lull from political turmoil will last for another year and beyond. A weak Italian coalition or a euro-sceptical administration may ignite doubts on the sustainability of the eurozone economic model.
I do not think that the Brexit issue will disrupt the governance of the eurozone in any significant way, which is not the same as saying that the UK will proceed with its plans to leave the EU smoothly. I also fear that the return of inflation, rising oil prices and the withdrawal of support by the ECB may prove to be a severe shock on growth prospects in the eurozone.
The strong euro has helped to absorb the shock of rising oil prices. But with global economies growing at a significant rate, pressures on oil prices will continue to be one of the major threats for 2018.
Policymakers in Germany are warning against complacency and being ‘naïve’. Benoit Coeure, a member of the executive board of the ECB, recently told a meeting in Ljubljana that “the ECB made it through the euro crisis and managed to help turn the region’s future with breaching its mandate. But to think that the current economic expansion will heal all wounds is naïve”.
Coeure calls for more integration in services and financial markets as well as a more complete banking union. Very shrewdly he concluded that “Realpolitik will dictate the speed of reforms”. This comment is particularly relevant as two major issues remain just work in progress.
Tax harmonisation will continue to be advocated by larger EU member states but resisted by smaller countries as it would undermine their competitive advantage. Banking reform following the introduction of the bail-in concept is still uncompleted with countries like Italy finding it difficult to speed up the reform of their banking system.
These issues may well lead to some new two-speed EU structure with France and Germany driving the high-speed lane and perhaps Italy leading the low speed one.
External threats come from the way Trump’s US pursues its protectionist economic policies. It will be no surprise if US politics will continue to be as baffling as they were in the past year.
This development is not good for the US and the rest of the global economy.
johncassarwhite@yahoo.com