The Euro area ended 2016 with a bang, according to BoAML, although growth and inflation will be hump-shaped. In December, the ECB ended the 2015/16 experiment of monetary policy covering for fiscal easing. But potential growth remains low. The UK is not really in much better shape: it is now a 1-1.5% growth economy, meaning low rates and austerity for longer.
The euro area ended 2016 with a “bang”. BoAML’ analysts are now tracking 4Q16 GDP growth close to 0.5% qoq, slightly above our 0.4% forecast. An even bigger “bang” came from inflation accelerating to 1.1% in December from 0.7% in November due to energy prices.
More of that is to come in the next months. We have updated our inflation forecast, and now see euro area inflation accelerating to 1.7% in April.
Time for cheer and ECB taper? Experts are sceptical. By end-17, headline inflation will be back to 1.4%- core inflation will remain almost unaffected. Instead, “bad” inflation will choke real income growth – the oil price tailwind of the past two years turns into a headwind. This week, they take the occasion to re-publish their last Europe Economics Weekly of 2016, which was their Europe-specific Year Ahead, with an update of inflation forecasts after the December surprises in the Weekly View.
BoAML’s fundamental views have not changed: growth and core inflation lack momentum, tailwinds are fading and despite more QE announced last December, the risk of a policy mistake this year is high. The 2015-16 experiment of extraordinary monetary easing to provide fiscal leeway sweetening the hard pill of structural reforms ends. The ECB has withdrawn the open-ended nature of QE, endorsed higher (and potentially rising) real rates, leaving the economy with more strained fiscal trajectories, again.
A sense that we are past the “Draghi peak” colours our view. We believe we are back to a disciplinarian version of the Euro area, with very little room for mistakes. Europe is stuck with low long-term potential growth, including in core countries (details in DE, FR, IT, SP).
The UK is not necessarily in a better shape, UK growth should slow as a real income squeeze and uncertainty take their toll. But those are not the only, or most important, reasons to be downbeat. Productivity has stagnated, the population is aging and net immigration likely to fall. The UK is a 1-1.5% growth economy. Actions bring consequences.
We are still trying to understand how Brexit materialized, because what drove Brexit matters a lot for decisions that will affect the economic outlook. Some have argued it was a populist protest, suggesting greater govt spending. But it could be that the risky option is the new normal. Either way, the economically ‘rational’ option is unlikely now to be the one chosen, leaving us pessimistic on our forecasts.