Political Uncertainty Could Threaten Europe’s Benign Outlook

Though Euro-area economic growth appears to have extended into the second quarter, political uncertainty could mar the region’s benign economic forecasts, states Goldman Sachs.

Huw Pill and team at Goldman Sachs highlighted the positive impact of the euro and oil price weakness that’s still in the pipeline in Europe in their May 21, 2015 research report titled: “Europe’s outlook: The recovery broadens but political risks linger.

Pickup in economic growth in Europe

The Goldman Sachs analysts point out that, thanks to the GDP rising by 0.4% Q/Q in the first quarter and business surveys pointing to continued recovery in the second quarter, economic growth in Europe picked up at the start of 2015. However, the analysts are surprised at the composition of the growth, with France, Italy and Spain contributing more than their expectations while Germany and the rest of Europe disappointed relative to their expectations:

Europe area growth

The analysts believe both the positive surprise to France’s Q1 GDP and the negative surprise to Germany’s Q1 GDP primarily reflect volatility in the data rather than pointing to a significant change in the underlying performance of either economy. Moreover, thanks to evidence of stronger growth in Spain and Italy, the analysts are revising their growth forecast for these economies higher while revising growth in Germany slightly lower.

Europe GDP growth forecasts

The analysts point out that the net effect of each of these changes on their forecast for the Euro-area as a whole is broadly neutral for 2015 but positive for 2016.

Euro’s growth won’t falter in 2016

Huw Pill and team note that last year, Euro-area activity data improved significantly in the first few months of the year, only to slow disappointingly as the year progressed. However, the analysts believe it is unlikely that growth will falter as it did last year. They anticipate near-term risks relative to their forecasts as being skewed somewhat to the upside.

Considering the importance of euro and oil price developments for the growth outlook, the analysts reviewed how far both have fallen and their impacts for output growth. They note that, despite the euro’s rise in the past month, its real effective exchange rate has fallen by around 12% from its 2014H1 average, a development which they expect to boost the level of the Euro-area GDP by a little under 1% over a period of two years.

Recent appreciation in Europe

Similarly, the analysts note that despite their recent rise, oil prices in Europe have dropped by 30% from their 2014H1 average, a development that they anticipate will boost the level of Euro-area GDP by a little over 1% over a period of two years:

Europe and oil price effects

However, the Goldman Sachs analysts view political uncertainty as the main risk to their relatively benign economic forecasts. They point out that while European growth improves, the impasse between the Greek government and its official creditors has seen Greece edge closer toward default and a possible exit from the Euro-area. The analysts reiterate that their central expectation remains that some form of accommodation will be reached, though the probability of worse outcomes has risen. Moreover, the analysts note that possible disappointing global growth has also added a separate risk to the Euro-area outlook.