Europe´s Economy on a Solid Growth Path

The economic recovery in the euro area continues. A sustained acceleration of the pace of recovery is, however, still not in sight. In times of increased uncertainty and with tailwinds from lower oil prices fading, the euro area economy is expected to expand at a moderate pace with GDP rising by 1.6 per cent and 1.5 per cent in 2017 and 2018, respectively. This is the picture being painted in the latest euro area economic outlook of the EUROFRAME group, which comprises ten of the most respected economic forecasting and research institutes in Europe, including the Kiel Institute. The assessment is based on the forecasts of EUROFRAME institutes. "The upturn in Europe is stable at a moderate level, the prospect gives reason for optimism, if not for euphoria," Klaus-Jürgen Gern, expert on the international economy at the Kiel Institute, said.

The labour market situation therefore will continue to improve with the unemployment rate at the euro area level forecast to decline by close to ½ of a percentage point per year from the 10 per cent rate registered in 2016. Consumer price inflation has picked up recently in response to higher energy prices, but underlying inflation has remained low and EUROFRAME institutes do not expect that it will rise to the ECB’s target of close to 2 per cent any time soon.

According to the EUROFRAME forecast the driving forces for economic development in the euro area include a modest increase in oil prices, a gradual strengthening of external demand, with US growth generally expected to accelerate to close to 2½ per cent, and an exchange rate that more or less remains at its current competitive level vis-à-vis the US-dollar. US money market rates are expected to be gradually raised to a level of 1.5–2 per cent by the end of next year, whereas the ECB will keep the Main Refinancing Rate at zero for at least another 1½ years.

Supportive factors such as low interest rates and a low external value of the currency are accompanied over the forecast horizon by a neutral aggregate fiscal policy stance in the euro area. At the same time, however, the temporary stimulus to purchasing power from lower oil prices is going away, unresolved structural issues, such as weak banking sectors in a number of countries, continue to weigh on the recovery. “Increased political uncertainty, including from the British decision to exit the EU, may negatively impact euro area on the economy in the coming months”, Klaus-Jürgen Gern said. “The economic impact of the decision of the United Kingdom to leave the EU is still hard to assess, given the high amount of uncertainty about the nature of the future relationship.”

In the long run, the level of trade could be substantially less than in the counterfactual of remaining in the EU, EUROFRAME institutes expect. Estimations suggest, that total trade in goods of the UK with the EU could decline, relative to the counterfactual by 35 per cent in case of a free trade agreement and up to 61 per cent, if the UK only transits to a WTO status. In the short run, the negative effects so far have been less pronounced than initially expected, but uncertainty could still substantially raise risk premia and weigh on investment, especially in the UK. The EUROFRAME group did a detailed analysis of the impact of the Brexit for the individual countries represented by EUROFRAME institutes. Direct repercussions on growth in other European countries through trade linkages are so far mostly related to the devaluation of Sterling against the euro and likely to be rather limited, with Ireland and the Netherlands particularly benefited. Indirect effects through uncertainties and changes in European policies triggered by the British decision could be significant but are much more difficult to assess.