Are we all becoming too optimistic about Europe?
Bet you didn’t expect to see those eight words printed this year, did you? Neither did I, if I’m honest. We European economists don’t know what to do with ourselves; we simply aren’t programmed for these levels of unalloyed positivity.
But two things can be true at once. The wave of fiscal activism unleashed by Germany’s spending splurge could genuinely lift the continent out of its decade-long malaise. It could also make next to no difference to the growth story in 2025.
Maybe I’m being overdramatic (an economist, dramatic? Never!). However, it was notable how my colleagues made only minimal changes to their 2025 growth forecasts. Put simply, the impending trade war still looks like a much bigger deal for the eurozone economy this spring and summer than any boost to government budgets.
Remember that we’re little more than a week off the publication of the Trump administration’s varied investigations into unfair trade practices and deficits. And for all the flip-flopping on Canada and Mexico tariffs since inauguration day, we think sweeping and potentially long-lasting tariffs on Europe are just days away. Our trade expert, Inga, explains more in her latest video.
All of this explains why I’m still having a hard time seeing European growth taking off in quite such a meaningful way this spring. Certainly the activity data we’ve had so far this year hasn’t been scintillating.
It seems the ECB agrees. I’m struck by how even some of the more hawkish members of the Governing Council aren’t ruling out another rate cut in April.
That’s not our base case, but speaking to our ECB guru, Carsten Brzeski, he reckons a hold at the next meeting certainly isn’t a done deal, not least if Europe finds itself in the midst of a rapidly escalating tit-for-tat trade war.
As for that massive €500bn infrastructure fund, the question lingering in the back of my mind is how quickly the cash can land in the German economy. Certainly, the political incentives are there to get things moving; Carsten reminds us that there are crucial state elections next year.
But if it’s anything like it is here in Britain, finding the proverbial shovel-ready projects can take time. I’m reminded of the infamous car tunnel under London’s River Thames, which has cost upwards of £1bn, taken several years, and not a single ton of earth has yet been shifted.
Maybe woeful infrastructure deployment isn’t the only cautionary tale Britain has for the rest of Europe. In many ways, the UK is six months ahead. It unveiled big changes to its fiscal rules and a sizeable budget boost last October. The rise in bond yields and Bank of England interest rate expectations will be eerily familiar to anyone tracking eurozone borrowing costs right now.
But those market moves are forcing a partial rethink upon the Treasury. More money on debt interest means less for everything else. Spending cuts are widely expected at next week’s Spring Statement and we think further tax rises are inevitable come the next budget in Autumn.
Despite sweeping changes to the European Commission’s budget rules, something very similar risks happening elsewhere. Bond yields are higher than they were a month ago and will keep rising, judging by our team’s latest forecasts. Higher defence spending could ultimately necessitate cuts elsewhere, just as we’re seeing in Britain.
If that happened, then my concern is that the growth impact would be asymmetrically negative. Austerity hits the economy today. Higher defence and infrastructure won’t, either because of domestic production constraints (for the former) or potentially long lag times (for the latter). I’m obviously getting ahead of myself a bit here, but it’s another reason to be wary about a big upswing in European growth this year.
It’s not all bad, of course. Europe’s jobs market remains a bright spot. As does consumer spending though, as Bert Colijn says, a lot hinges on an improvement in confidence. Speaking of confidence, next week’s Purchasing Managers’ Indices will give us an early sense of whether companies are quite as jubilant as their soaring stock market valuations imply.
Europe is bathing in sunshine – literally and metaphorically. But don’t be fooled: cool April showers are only just around the corner. Happy weekend!
