Eurozone likely to get more stimulus as growth halves

LONDON – It seems that the strong start to the year was another false dawn for the eurozone economy and that the European Central Bank will have more to do in the months ahead to shore up growth.

New figures released Friday confirmed that the eurozone, which is made up of 19 countries from Ireland to the west to Cyprus in the east, suffered a sizeable slowdown in the second quarter of the year despite a number of stimulus measures that the European Central Bank has thrown at it.

In its first estimate for the April to June period, Eurostat, the EU’s statistics agency, said growth across the single currency bloc eased to a quarterly rate of 0.3 per cent from the previous quarter’s 0.6 per cent. The eurozone’s growth was equivalent to the 1.2 per cent annualized rate also reported Friday for the United States.

The decrease was in line with market expectation and the euro was steady at around $1.11.

No explanation for the slowdown was provided in the report but analysts said growth was likely hurt by a moderation in the tailwinds that had helped in the first quarter. The sharp drop in oil prices has reversed slightly, meaning that the boon to households and businesses has largely played out. Same with the export-boosting depreciation of the euro, which has recently steadied.

The June 23 referendum in Britain may have also caused some uncertainty, prompting businesses to delay investment decisions. The evidence since Britain voted to leave the EU shows that Europe has brushed aside much of the uncertainty generated by the decision.

However, most forecasters think it will weigh to some degree on growth over the coming months, especially if the discussions around Brexit drag — few think annual growth will be anything much more than a modest 1.5 per cent this year and next. As a result, many economists think the ECB will back a further stimulus package at its next policy meeting on Sept. 8.

“The weakening in economic growth, together with the downward revisions in expectations for the outlook are setting the scene for more stimulus measures,” said Danae Kyriakopoulou, managing economist at the Centre for Economics and Business Research in London.

Kyriakopoulou estimates that the ECB is more likely to expand its bond-buying stimulus program rather than further cut its interest rates, which has the potential to undermine banks’ profitability.

The results of stress tests of EU banks, due to be published later Friday, are expected to show that many banks, particularly in Italy, are struggling with the super-low interest rates, which have fallen further since the Brexit vote. The ECB earlier this year cut its main interest rate to zero and has pushed the rate it charges banks to park their cash at the central bank below zero, meaning they have to pay for the luxury.

The ECB could choose to expand its bond-buying stimulus program beyond its current expiry date of March 2017 or increase the amount of bonds it purchases each month from 80 billion euros ($88 billion). The program pumps newly created money into the banking system in the hope it will increase lending and raise inflation to levels more consistent with steady growth.

One moderately bright spot for policymakers at the ECB is that inflation is heading the right way.

A separate Eurostat report showed consumer prices across the region rose to 0.2 per cent in the year to July from the previous month’s 0.1 per cent. The core rate, which strips out volatile items such as food, alcohol, energy and tobacco, held steady at 0.9 per cent.

Though the headline rate is still far short of the ECB’s target of just below 2 per cent, the prospect of falling prices has diminished over the past few months, largely because the sharp decline in oil prices seen last year has come to an end.

The main motivation behind the ECB’s recent stimulus efforts was to make sure that prices don’t fall over a long period of time. So-called deflation can weigh on economic activity as consumers delay spending in anticipation of lower prices and businesses grow reluctant to invest and hire.

Recent evidence has shown that they have become more somewhat inclined to hire, with unemployment across the eurozone falling in the past few years at a steady, if unspectacular, rate.

Eurostat figures on Friday showed that the number of people out of work in the eurozone dropped by 37,000 in June to 16.27 million but that the unemployment rate held steady at near five-year lows of 10.1 per cent. One clear improvement is Spain, where unemployment has fallen consistently over the past couple of years and in July hit 19.9 per cent, the first time it’s been below 20 per cent since July 2010.

However, the region still has a long way to go to get unemployment down to the levels of the U.S., where the rate is only 4.9 per cent. And youth unemployment remains high at 20.8 per cent.

Tomas Holinka, economist at Moody’s Analytics, warned about a potential slowdown in the labour market improvements due to a variety of factors, including Britain’s exit from the EU, which could hinder hiring in sectors like finance.

“The U.K.’s divorce from the EU will weigh on the euro area through three main channels — stifled trade, reduced foreign direct investment, and lower public investment from EU funds once the U.K. stops contributing,” he said.