Eurozone economy: a fragile stabilisation
The eurozone economy slowed sharply in H2 2018 and started 2019 on a weak footing. We believe that growth will stabilise, albeit at lower rates, spurred by positive factors such as a solid labour market, an expansionary fiscal policy, more accommodative monetary policies globally and China’s stimulus measures. We forecast growth of about 1% for 2019, down from 1.8% in 2018 and 2.4% in 2017.
However, the bloc is still exposed to considerable downside risks, mainly due to political uncertainty both domestically and externally, particularly with the recent resurgence of trade tensions between the US and China. Its economy looks vulnerable because it lacks the tools to deal with the next crisis. The response to the next downturn must come from fiscal policy. However, insufficient progress has been made to create a eurozone budget.
The impact of the European elections
The outcome of the European elections this month could therefore pose further implications for the eurozone’s ability to manage the next economic downturn. Europe has been no stranger to rising populism. In June 2018, the anti-establishment Five Star Movement and the right-wing League formed a coalition government in Italy, while the far-right Alternative for Germany party made its debut in the German Parliament following the 2017 election.
Undoubtedly, economic conditions have taken their toll on the reputation of the EU project – in particular, concerning its ability to deliver prosperity. Indeed, the last two recessions in Europe occurred in quick succession and were followed by slow and uneven recoveries. In addition, the fact that national governments have tended to blame European institutions for domestic issues has not helped.
These factors, together with the fact that European elections traditionally attract the protest vote, suggest that populist parties are likely to enjoy significant advances in the elections this month.
Populist party gains
However, European populists are characterised by a high degree of fragmentation. While they all agree on the principle of repatriating sovereignty from the EU back to the nation state, they have no consistent views on other issues and policies.
Our bottom line is that the three mainstream parliamentary groups – the Popular Party, the Socialists & Democrats and the Liberals – will probably maintain control of the European Parliament. In turn, they will be able to decide the distribution of the EU top jobs but, most importantly, they will need to cooperate, particularly on fiscal policy.
A common fiscal framework
Currently, it looks like the ECB has reached its limits, despite reassurances that its toolbox is still plentiful. There are limits to how low negative rates can go and at the same time it appears that quantitative easing from the ECB has probably reached its political constraints. There is only one credible response to the next downturn: it must be driven by fiscal policy – and, more crucially it must involve a common fiscal framework given how shocks are usually asymmetric across countries.
A common fiscal framework would complete and underpin the monetary union, but it will not be easy to achieve as different countries have different fiscal spaces. Equally, the availability of fiscal transfers within the union poses moral-hazard issues.
Last December, eurozone leaders agreed to create a eurozone budget as an instrument for convergence and competitiveness of the bloc. However, its size and structure will be determined within the constraints of the wider EU Multiannual Financial Framework (MFF) and whilst the features of such a budget should be agreed by June, a delay to its implementation looks likely.
Indeed, the debate has quietened recently, at least publicly. With the European elections fast approaching, the focus has shifted to campaigning and preparing the ground to decide who will occupy the EU’s top positions. Any delay to the MFF has a knock-on effect on the eurozone budget. For now, it looks unlikely that the net MFF will be approved before summer.
Populist parties will probably gain enough power to disrupt decision-making processes, eroding the functioning of European institutions from within. This would hinder the already challenging process of integration, undermining the eurozone’s ability to tackle the next downturn or recession. It will depend on whether the next Parliament can advance the ongoing reform process and strengthen the EU project. In this respect, the upcoming elections are crucial.