European recovery on track, but moderate and uneven

The Eurozone recovery remains on track, but it is slow and uneven. Real GDP in Q1 disappointed. First, the headline numbers of +0.2% q/q and 0.9% y/y were below consensus. Second, the divergence within the Eurozone increased again, with Germany and Spain growing at decent rates of 0.8% q/q and 0.4% q/q, respectively, while France and Italy saw rather weak growth of zero and -0.1% q/q, respectively.

The Netherlands also disappointed (-1.4% q/q), although this was largely due to weaker natural gas production during the mild winter. In light of the soft Q1, we have tweaked our 2014 Eurozone GDP forecast marginally lower, to 1.0% from 1.1% (consensus 1.1%). However, we maintain our 2015 forecast of 1.5%, in line with consensus.

Given very low inflation, nominal GDP in the Eurozone will grow only 1.7% this year and 2.7% in 2015 – better than in 2013 (1.1%), but still much slower than would be desirable to support debt deleveraging. The key drivers of the recovery remain: (1) the gradually improving external environment; (2) very easy monetary policy; (3) low inflation supporting household consumption; and (4) a moderation in fiscal austerity.

And, as the recovery proceeds, we also expect some pent-up demand to become effective, at least in
the core of Europe. It is true that headline PMIs have softened somewhat in recent months, while
remaining above the neutral level of 50 in the Eurozone overall and most individual countries (exception: France).

The pullback seems to have been caused mainly by external factors (e.g. Ukraine), whereas the domestic prospects seem to have improved further. For example, manufacturing PMIs, which are more export related, softened a bit, while services PMIs have strengthened further or held up better, respectively. Other domestic indicators, such as consumer confidence and retail sales, have also improved.

Labour markets across the Eurozone are stabilising, with some improvement visible, and wage dynamics are improving gradually, in nominal terms, but also in real terms, supported by very low inflation. This helps.

Overall, the Eurozone expansion will continue to be driven mainly by domestic demand whereas net exports should moderate, as imports recover. As a result, we think the Eurozone current account surplus might be about to peak.