Eurozone blip threatens to become a downturn

Evidence is building up of broad-based European economic weakness

After a global expansion that started off in a staggered fashion, a bout of nerves is now gripping the major economies in an unhelpfully synchronised wave. Signs of trouble in China and the US are accompanied by an ever-extending period of weakness in the eurozone, an economy which was slower than the other two to get going after the global financial crisis and has performed in an adequate but not spectacular way since.

Having chugged along for more than five years, the eurozone economy as a whole seemed to hit some turbulence last summer. More recently, data suggest the blip is at risk of turning into a sustained downturn. This week it was revealed that policymakers at the European Central Bank considered downgrading the bank’s economic forecast when they met in December.

If the slowdown continues, the timing would be bad for moderate political parties. European parliamentary elections this year are an opportunity for radical populist movements to take votes from the political centre. If those parties can argue that the European establishment’s orthodox and fiscally conservative economics has failed to bring growth and reduce inequality, it will provide ammunition for their appeal to discontented voters ready to reject the status quo.

Survey data suggest that eurozone growth ended the year very weakly. To some extent the gilets jaunes protests in France helped to push down eurozone-wide purchasing managers’ reports of output, generally a good leading indicator of gross domestic product. However, putting such weakness down to temporary factors such as the French protests has proved misplaced before.

For several years, Germany has provided one of the most reliable growth engines of the single currency — though, critics have charged, partly at the expense of other eurozone economies by expanding exports within the zone. A series of wobbles beginning last summer were initially attributed to one-off events. In particular, a new set of emissions regulations disrupted production in the car industry.

The longer the weakness has continued, however, the more the slowdown has appeared more fundamental. Data published this week show German industrial production dropping sharply, and exports and imports both contracting, in November. The tensions over global trade clearly have not helped, but the weakness looks broader-based. Germany may well record a technical recession — two quarters of contracting GDP — in the second half of last year.

More positive news comes from the eurozone labour market, where falling global oil prices are likely to push up real wages and hence consumer demand, and investment, with signs of capacity constraints in some economies providing an incentive for capital expenditure. Fiscal policy is also likely to be moderately stimulative. Inflation in the eurozone is low — in fact uncomfortably so — which suggests domestic demand can be run faster without letting price rises get out of control.

May’s European Parliament elections will inevitably be regarded in part as a vote on how well the eurozone economy is performing for all of its citizens. In reality, the range of voters’ motivations — non-economic as well as economic — will be far wider than that. But, in general, although the European Central Bank probably saved the eurozone economy from total collapse, it is not a good sign that the continued recovery is transparently in doubt. Time is running out before the elections for the economy to prove the bulls right, the weakness to prove temporary and the steady, if unremarkable, expansion to resume.