Economics & Market Updates

Euro Zone: Upcoming Elections in the Netherlands, France and Germany Pose Downside Risks to the Fragile Recovery

The recovery in the Euro Zone (EZ) economy is continuing at a moderate pace and we expect the economy to grow at 1.7% in 2017, similar to the growth seen in 2016. Consumption demand remains the mainstay of the economy. Investment activity continues to remain weak and is dependent on global developments and financial stability while the external sector could see a further uptick on the back of a weaker euro. While headline inflation is expected to increase on the back of rising commodity prices and a weaker euro, core inflation is likely to remain in the range of 0.7-1%. This should see the ECB maintain its loose monetary policy stance for some time to come. The uncertainty over upcoming elections in the Netherlands, France and Germany pose downside risks to overall GDP growth in 2017.

The EZ grew at a moderate pace in 2016 despite risks surrounding Brexit, the banking sector concerns and referendum in Italy, and the uncertainty ahead of the US elections. The recent firming up of industrial production in 2H2016 was driven by an increase in the production of pharmaceuticals, machinery and equipment, and electricity and gas. The gradual improvement in industrial production was also broad based across the major EZ countries.

Improving consumer confidence, a declining unemployment rate and a steady increase in credit to households are expected to remain supportive for private consumption going forward. The trend in retail trade ex-auto and consumer goods imports has continued to improve suggesting that private consumption should remain the main driver of overall domestic demand in the economy. Overall investment activity continues to remain weak despite a rise in the composite Purchasing Managers Index (PMI). This is reflected in weak capital goods imports, declines in construction and industrial confidence and a poor offtake in credit to the non-financial sector.

With respect to trade activity, the trade surplus has continued to widen driven by rising non-oil exports. The rise in non-oil exports can be explained by a weaker euro and a favorable base effect. The pace of decline in non-oil imports have seen a slowdown driven by increasing imports of consumer goods. Inflation is expected to pick-up on the back of rising commodity prices but remain lower than the ECB’s 2% inflation target. Consequently, the ECB is expected to maintain an accommodative stance over the coming year. Heightened uncertainty about the outcome of elections in the Netherlands, France and Germany could lead businesses and households to hold back on spending, posing downside risks to the fragile recovery.

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