Eng 2015 08 eurozone

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Global Outtlook – 25 November N 20 015

Euro ozone – D Domestic c demand streng gthens

Aline e Schuiling Senio or Economist Tel: +31 + 20 343 5606

 Dom mestic dema and in the eurozone is gathering g m momentum  Net exports willl be modesttly positive for GDP gro owth in 2016 6 and 2017 ationary pre essures rem main subdued - further E ECB easing on the card ds  Infla

aline.schuiling@nl.abn namro.com

Eurozo one consum mer is leadin ng the recovery Consum mption has been n the largest co ontributor to GD DP growth this year. Private consumption c grew by 0.5% and 0.4% qoq q in Q1 and Q2, respectively. This lifted the yyoy expansion n to 1.9% in 2015Q2, which is well above overall GDP growth off 1.5%. GDP grrowth slowed down d somewha at in Q3 (to 0.3% qoq from 0 0.4% in Q2). Although A the de etails have not bbeen published d yet, we think that priva ate consumptio on continued contributing c significantly to groowth. Meanwhile, governmen nt consump ption, which ha ad been depres ssed by austerity measures dduring the past few years, picked up in the e first half of thiis year as well.. Private consu umption has beeen benefitting from low inflatiion (the drop p in energy pricces in particula ar) and a gradu ual labour markket recovery. Employment expande ed moderately iin the first half of the year, wh hile the unempployment rate fe ell from 11.4% to 10.8% between Decem mber 2014 and September 20 015. The declinne in unemploy yment has supporte ed wage growth h. Hourly nominal wages rose e by around 2.00% yoy in Q1 and a Q2, which,, combine ed with low infla ation, resulted in a rise house ehold’s real grooss disposable income.

Moreove er, following ye ears of austerity y, fiscal policy is i no longer beeing tightened in i the majority of eurozone countries. Th his implies thatt in the eurozon ne as a whole, the governments’ structural budget deficits d (the defficit corrected for f the impact of o the businesss cycle and one e-off income orr expenditture) will rise s lightly in 2015 and 2016. We e expect consuumption to rema ain a major pillar 6 and 2017. Th for GDP growth in 2016 he labour mark ket recovery shhould continue and real wage growth is s expected to rremain positive e.

Contrribution to GD DP growth contribu ution to GDP grow wth, %-pps yoy

E

2 1 0 -1 -2 -3 05

07

0 09

Prrivate consumption

11

13

Foreign trrade

15

17

Fixed investments

Source: Thomson Reuters D Datastream

i tto strengthe en Fixed investment Fixed inv vestment was llacklustre in the first half of 2015. It expandeed by 1.4% qo oq in Q1, but subsequ uently contracte ed by 0.5% in Q2.

Q We expectt fixed investmeent it to gather pace in the coming two t years, larg gely because co orporate profita ability is improvving and bank lending standa ards on loans s to companiess are being eas sed. Despite the e increase in w wage growth, th he rise in unit labour co osts still is rela atively subdued d. Indeed, productivity growthh and reduction ns in non-wage labour co osts in a numb ber of eurozone e countries hav ve limited the riise in unit labour costs.

Moreove er, low energy p prices have su upported corporate profitabilityy. Consequenttly, both corporrate

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Global Outtlook – 25 November N 20 015

profitability from a maccro-economic perspective p and d the gross opeerating surplus of non-financial companies have impro oved significanttly (the share of o profits in GDP P increased by y 0.5 percentag ge oy in 2015Q2, w while the gross s operating surrplus jumped bby almost 5% yoy). We expecct points yo corporatte profitability to o continue to grow g next year and in 2017.

Bank B lending standards fo or companies ease

Corporate profitability im mproving yoy

% yoy

3 2 1 0 -1 -2 2 -3 3 -4 4 -5 5

12

E

8 4 0 -4 -8 -12 -16

01

03

05 07 09 11 Ch hange in profit shaare in GDP (lhs)

13

15

1 17

ba alance

70 60 50 40 30 20 10 0 -10 -20

Tighteer

Eassier 9 10 11 12 13 1 14 15 16 03 04 05 06 07 08 09 Large firm ms

Grross operating surrplus & mixed income NFCs (rhs) Source: S Thomson R Reuters Datastrea am

SMEs

Sou urce: Thomson Re euters Datastream m

Net exports to ben nefit from eu uro deprecia ation and sttronger glob bal trade Net expo orts were mode estly positive fo or GDP growth in the first halff of this year, but b the contributtion seems to h have declined in the second half. h Exports too BRICS and other emerging markets are weighing d down export grrowth, while the e positive impaact of euro wea akness of 2015 5 o have petered d out. Net expo orts should contribute modesttly to growth ag gain next year and a seems to in 2017. We expect glo obal trade to grradually pick up p, while the eurro is expected to depreciate noticeab bly, due to the d divergence in monetary m policy y between the ECB and the US U Fed. On the e other hand, imports sh ould be stimula ated by the stre ength of domesstic demand. Having H said tha at, there are e increasing do ownside risks to the outlook as a the global ecconomy might turn out to be weaker due d to slower g growth in emerrging markets.

Inflatio on to stay w well below th he ECB’s tarrget for a lon ng time Inflation has been closse to zero in the e first ten months of this year.. Inflation is be eing depressed by energy prices. p Core infflation – excl. energy e & food – crept higher during the yea ar and stood at 1.1% in October. There e is no sign of broad price falls but inflation is far from the ECB’s target. he fall in the eu ro and the ong going economic c recovery, we do not expect a deflationary Given th scenario o to materialise e. Inflation shou uld move mode estly higher oveer the coming months m as the depressing impact from m food and ene ergy price inflattion unwinds. Inn addition, the fall in the euro o omic recovery should push up p core inflationn. However, it will w likely remain n and the stronger econo ow the ECB’s g goal (close to but b below 2%) for f a long time.. We see overa all inflation end ding well-belo up at jus st below 2%, on n average, in 2017.

2

ECB to o ease mone etary policy further In its September staff p projections the ECB forecast inflation to be 1.1% in 2016 and a 1.7% in 20 017, CB’s price stability goal. This m means there is a risk of inflatiion which is still somewhatt below the EC g dislodged if fu urther downside risks to inflattion were to ma aterialize. We expectattions becoming think, the e unexpected sslowdown in GDP growth in Q3, Q as well as tthe continued low l level of energy prices p will prob bably have raise ed worries at th he ECB about ffurther declines in the outlookk for inflation. Indeed, the e account of th he ECB’s Octob ber Governing Council meeting gave a stron ng ear from the dis scussion at thee meeting that the t ECB is veryy signal in this direction. It was very cle concerne ed that inflation n will turn out even e lower than n it projected inn September and that it felt compelle ed to act at the e next meeting.. We think, the central bank w will almost certa ainly deliver a

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Global Ou utlook – 25 November 2015 2

stimulus s package in De ecember. We expect e the ECB B to increase thhe scale of its monthly m QE program mme, expand th he eligible unive erse of assets to include regioonal bonds and d to extend its asset pu urchases to beyyond September 2016. We also expect a reeduction in the ECB’s deposit rate taking it further intto negative terrritory. We expe ect the ECB to keep its policy rates unchang ged in 2016 and a 2017.

Inflation, headline and co ore

3M 3 interest rate and 10Y go overnment bond yield

% yoy

%

4

3.5 5 3.0 0 2.5 5 2.0 0 1.5 5 1.0 0 0.5 5 0.0 0 -0.5 5

3 2 1 0 -1

11

0 05 06 07 08 09 10 11 12 13 14 15 5 01 02 03 04 Tottal Core rate C ECB target Source: S Thomson R Reuters Datastrea am

Refi rate

12 2

13 Deposit rate

14 3M Euribor

15

16

Germany 10Y

Sou urce: Thomson Re euters Datastream m

Interes st rates to re emain at low w levels, while euro dep preciates Short-term interest rate es (3m Euriborr) are likely to fa all further into nnegative territo ory given the ext year, and ECB’s deposit rate cut . They are likely to remain in negative territoory over the ne y even until the e end of 2017. Meanwhile, lon ng-term interesst rates are exp pected to fall probably slightly during d the rest of this year. Th his reflects ong going and enhaanced ECB stim mulus, which should offset o the impacct of the Fed’s first rate hike. Long-term inteerest rates are expected to risse modestly y during the co ourse of next ye ear and in 2017 7, as markets sstart to focus more m on improvving economic fundamentalls. The low leve el of short-term m interest ratess should limit th he rise in longes, however. D Due to the diverrgence in mone etary policy in tthe US and eurozone, the term rate EUR/US SD is expected to fall this year and in 2016. We expect it too reach 1.05 att the end of 2015, to move to parity aroun nd March 2016 6 and to drop fu urther, to arounnd 0.95 at the end e of 2016. In ainst the dollar, as markets sttart pricing in th he end of policyy 2017, the euro should appreciate aga easing by b the ECB, wh hile the Fed is already a well ad dvanced in its ppolicy tightening cycle.