Europe starts to grow at long last but Trump could still spoil party
The eurozone appears finally to be coming to life even as political uncertainty rises by the day, writes Dan O’Brien
SOMETHING is stirring in Europe. Almost 10 years on from the beginnings of the worst slump since the Great Depression, the continental economy appears to be picking up its plodding pace of growth. Last year, the eurozone economy outpaced that of the US for the first time in almost a decade. This year is shaping up in much the same way. Economic forecasts for the eurozone — for what they are worth — are being revised up almost by the week.
All this is happening against the backdrop of extraordinary political instability. The European integration project is going into reverse with the departure of Britain from the EU, and uncertainty abounds regarding future EU-UK relations — economic and otherwise.
In the nearer term, the impact of the rise of non-mainstream politics is causing growing economic uncertainty. Most immediately and most seriously, the (still slim) chance of the reactionary Marine Le Pen becoming president of France in May is causing, among other things, French government bond yields to rise markedly.
These issues all come on top of the North-South divide in the eurozone, with Greece’s bailout woes once again back in the headlines, Italy’s multiple fiscal, banking and political crises worsening, and Portugal never more than a step or two away from sliding back into trouble.
And as if Europe didn’t have enough troubles of its own, the continent is bracing for a possible tsunami coming from across the Atlantic. A plan by the Trump administration to impose a tax on all imports, including those from the EU, would amount to something close to a declaration of economic war.
If the new US president unilaterally erects trade barriers, Europe will have no option but to respond with counter measures on imports from the US.
Even if it stops there, and a tit-for-tat trade war doesn’t break out, one round of new barriers to transatlantic trade would likely have a discernible negative impact on the economies on both sides of the Atlantic.
Given how much trade Ireland does with the US, and how US multinationals in Ireland have highly internationally integrated supply chains, the Trump tax represents a real and material threat to the Irish economy in the short term (Irish exports to the US as a percentage of GDP are higher than any other European country, and similar to America’s immediate neighbours, Canada and Mexico).
As the Irish economy slowed in the second half of 2016, and as there are questions about the strength of its momentum in early 2017, the last thing it needs is a transatlantic trade shock on top of the trade shock that has already been felt from the Brexit-related decline of sterling.
In these circumstances, about the best thing that could happen is for Ireland’s most important trading partner — the rest of the eurozone — to grow more rapidly and, as a result, buy more Irish-made goods and services. Thankfully, that appears — finally — to be happening, as the slow recovery in Europe since 2013 gathers pace.
The best news from Europe is on the jobs front. The latest figures, for the third quarter of last year, show that close to three million more people were working in the 19 countries using the euro compared with 12 months earlier. Even better news is that rate of job creation is accelerating, reaching almost 2pc year on year by the middle of 2016. That, as it happens, was stronger than the rate of growth in the US, a country whose labour market is often thought of as more dynamic than Europe’s.
As might be expected, given so many differences among the 19 euro-area members, the jobs performance has varied by country. That said, it was almost universally positive.
Crisis-afflicted peripherals — Ireland, Greece, Spain — all enjoyed employment growth in the first nine months of last year that was well above the already strong average for the euro area. Although Italy and Portugal didn’t do so well, they both recorded passable rates of employment growth which helped bring joblessness down.
It is also worth pointing out that Germany, which has taken in the largest number of people since the surge of migration into Europe began over the past two years, has recorded one of the strongest accelerations in job creation over that period.
This suggests that whatever issues that may exist around social integration, new arrivals are being integrated into the labour market, something which forms a good basis to hope that the migration misgivings some Germans have will dissipate over time.
The pick up in the pace of growth in the euro-area economy has contributed, partially at least, to a sudden uptick in the rate of consumer price inflation.
In January, prices across the currency zone were 1.8pc higher than a year earlier. As recently as November the rate had been close to zero (where they remain in Ireland, by the by) and had stayed stuck at that level for the past couple of years.
The European Central Bank’s mandate is to keep the annual rate of inflation just below 2pc. As that is exactly where it is now, how will Frankfurt respond and, more specifically, is the day when it starts raising interest rates closer than it was just two months ago?
The latter question is of great importance for the Irish economy owing to the still very large debt overhang as a result of the credit binge up to 2008 — average Irish household debt (relative to disposable income) is higher than in every other country in the eurozone bar the Netherlands.
If interest rates were to rise by even a couple of percentage points, the increase in debt servicing costs would suck a lot of life out of domestic demand. That could be enough to tip the economy back into recession.
Mercifully, though, it still appears as if that day of reckoning will not come until well into next year, if not 2019. Much of the increase in inflation over the past two months relates to factors that were temporary or one-off, such as a jump in seasonal food prices and oil prices rising back towards more normal levels.
When these factors are stripped out and “core” inflation is measured, it remains below 1pc. On this basis, there is quite a way to go before the ECB gets inflation sustainably back to its mandated level.
There is also the matter of its two-year-old money-printing programme specifically designed to bring inflation back to target.
The ECB has given no indication that it will change its plans on “quantitative easing” as a result of the recent spike in the headline rate of inflation.
As Frankfurt is committed to continuing QE until December, it is all but inconceivable that it would move to raise rates while still printing money. All that said, a stronger economy and falling spare capacity in the labour market should ultimately lead to more inflation.
That will allow the ECB to ‘normalise’ policy, ending QE and bringing interest rates up from the zero levels they have been at since the Great Recession struck.
While this is to be welcomed, every silver lining has a cloud. For indebted Irish households and companies, as well as the Government, it makes sense to cut debt now before the cost of servicing it starts rising.
‘A Trump tax on imports would be close to declaring economic war’ ‘For indebted Ireland, it makes no sense to cut debt before costs rise’