Euro area growth stabilizes at subdued levels, while monetary policy is set to remain supportive in 2020
Euro area GDP has stabilized in recent months, albeit recording subpar quarterly annualized growth of close to, but below, 1%. A similar performance is expected in Q4. As a result, annual growth is anticipated at +1.2% in FY:2019 compared with +1.9% in FY:2018. Net exports are estimated to pose a drag of 0.3 pps on annual growth in FY:2019 versus +0.4 pps in FY:2018, thus representing the major source of the GDP growth slowdown in 2019, as exports decelerated significantly due to weak external demand. Domestic demand remains healthy, with private consumption growth of +1.2% in 2019 (contribution: +0.6pps) from +1.4% in 2018 (contribution: +0.7 pps).
Looking forward, international trade uncertainty is likely to remain in 2020, sustaining the muted dynamics for external trade. Assuming that the US does not proceed with the threatened tariff increase of 25% on imported cars and parts, economic growth is likely to remain at +1.2% in FY:2020 according to our estimates (see graph below).
The subdued trend for economic activity is expected to keep inflation at a low level, while at the same time, the improvement in the labor market will likely slow. Recall that employment grew by 0.5% qoq saar in Q3 and the annual growth stood at 1% yoy, compared with 1.5% yoy in 2018. In that context, consumers have turned more cautious regarding spending, with household savings at 13.2% of disposable income in Q2:19, the highest since early 2010, versus a trough of 11.9% in Q1:18. Overall, according to our estimates, annual growth of headline CPI will average 1.2% yoy in 2020, broadly stable compared with 2019 and of core CPI, 1.1% yoy versus 1.0% yoy in 2019.
Monetary policy accommodation was stepped up in September to support the economy, with the ECB, inter alia, lowering the Deposit Facility Rate (DFR) by 10 bps to -0.50%, as well as introducing a two-tier system for euro area banks’ excess reserves held in the ECB to mitigate the negative effects on their balance sheets. Moreover, the ECB reinstated net asset purchases under its Asset Purchase Programme (€2.65 trillion have been accumulated so far under APP) at a monthly pace of €20bn as of the current month.
With GDP growth below potential in 2020 and inflation below target, monetary policy support is expected to remain accommodative. However, the bar for additional easing is high in our view, as the effectiveness of a potential further easing has come into question, in view of already sub-zero nominal interest rates and ample liquidity in place.
As monetary policy effectiveness is declining, there are increasing calls to adopt more aggressive fiscal policies. However, according to the budget plans for 2020 of euro area countries, the fiscal stance for 2020 points to a moderate easing, with the structural primary balance at +0.4% of potential GDP from +0.7% in 2019 and +1% in 2018. This easing will be led by countries with substantial fiscal space, i.e. Germany (29% of euro area GDP | public debt: 59% of GDP in 2019) where the overall budget surplus is planned to decline to 0.6% of GDP in 2020 versus 1.2% in 2019 and the Netherlands (7% of euro area GDP | public debt: 49% of GDP in 2019) where the respective surplus is planned to decline to 0.5% of GDP in 2020 versus 1.5% in 2019.