Talking Heads – Aussichten für die Eurozone werden sich aufhellen, bevor die Herausforderungen wieder auftauchen

This is an audio transcript of the Talking Heads podcast episode: Springtime for the eurozone economy 

Andrew Craig: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing the macroeconomic environment and the outlook for the eurozone economy. I’m Andrew Craig, Co-head of the Investment Insights Centre, and I’m joined today by Mario Pietrunti, Senior Economist for the eurozone in the Macroeconomic Research team at BNP Paribas Asset Management. Welcome, Mario, and thanks for joining me. 

Mario Pietrunti: Thank you. It’s great to be here. 

AC: We had a weak economic environment, particularly in Germany, in 2023. It seems to be improving, but we’re expecting only muted growth this year, especially when we compare the eurozone with the US. And the longer-term growth prospects for the eurozone are also less favourable. Europe has a heavy reliance on traditional manufacturing and a relatively high exposure to international demand, which are handicaps for the eurozone economy. Of course, we’ve also had a series of shocks recently – the pandemic, then the energy shock. How do you see the current growth outlook for the eurozone? 

MP: Growth was fairly weak and feeble last year in Europe, but since the start of this year, we’re seeing an improvement in business and consumer sentiment, with surveys surprising to the upside. What is notable is that sentiment, even in Germany, has turned brighter and this is becoming more visible in hard data such as industrial production. [Activity in] core [eurozone] countries like Germany is gradually converging back to that of the ‘peripheral countries’ which have outperformed in the last few years. This suggests that growth is gradually picking up in the eurozone.  

GDP growth was fairly solid in the first quarter and we could see a repeat in the second quarter. The inflation outlook is also improving. Both headline and core inflation have fallen to below 3% in the last few months. Barring major shocks in the coming months, the direction of travel for this year is clear and quite consensual. We see core inflation hovering slightly above the [ECB’s} 2% inflation target for the rest of the year.  

Where we retain a slightly more bearish view than consensus is on the longer-term outlook, both on growth and inflation. We still see significant challenges to growth – weak European competitiveness at the global level, geopolitical headwinds, the low productivity of European firms, and last but not least, policy rates still in restrictive territory. This implies that inflation will weaken over time: we see it falling to just below the 2% target next year. As you can imagine, this is highly consequential for the ECB.  

AC: That sounds like a relatively benign outlook for inflation, in contrast to the US, where inflation seems stickier. There’s a lot of talk about divergence in terms of monetary policy between the US and the eurozone. Today is 30 May, and the ECB meets on 5 June and there’s an expectation that it will embark on the first in a cycle of interest-rate cuts. How do you see the implications of the current environment for the European Central Bank, and what do you expect from the ECB this year in terms of monetary policy? 

MP: The outlook is improving, but still uncertain, so the first cut in June now seems a done deal. But we also note that ECB policymakers are becoming increasingly cautious about the path ahead. It seems they have in mind as their base case just three cuts this year, one per quarter in meetings where they release their forecasts. There are two interim meetings, one in July and one in October, although the bar for cutting in July is much higher than in October. In October, we think the inflation outlook will be even more benign and will soften again. And by October, it will be much clearer for the ECB whether the Federal Reserve will cut rates or not.  

We think policy divergence per se shouldn’t be an issue and that the ECB is ready to accept some degree of divergence, as long as the next move for the Fed is a cut. However, if this narrative changes and hikes are brought back to the table, that would make the ECB uncomfortable and imply that any plans for further cutting would be put on hold.  

AC: Can you talk about the different trends you see across the countries that make up the eurozone? 

MP: When we think about the eurozone, we usually have a top-down view, but there’s also a bottom-up view. And the picture there is one of divergence, in that – in the last few quarters and years – ‘peripheral’ countries like Spain, Italy and Portugal have outperformed core and so-called semi-core countries like Germany and France. In the short term, we think this narrative remains broadly valid, although there are two factors I would like to highlight.  

One, as I mentioned, Germany is now gradually recovering and so the gap with the ‘peripheral’ countries should narrow over time. Second, on the other hand, you have Italy, where growth has been very strong in the last couple of years, but was mainly driven by fiscal policy and a generous tax incentive in the construction sector. As this tax incentive comes to an end, the construction sector will likely become a drag to activity, so we see feeble growth ahead for Italy.  

This brings me to the issue of fiscal policy – a key factor of divergence. Fiscal deficits are quite high compared to pre-Covid, pretty much in every country. Now, fiscal rules are back, and every country – in one way or another – is embarking on fiscal consolidation. But the trajectories vary across different countries. Cutting back spending, for example, is a bigger challenge for some countries than for others, and this matters when thinking about growth in each individual country.  

AC: As well as the ECB meeting on 5 June, there’s another important event: the European Union elections, in the second week of June. What are the issues at stake in these elections and the main economic challenges that the newly elected leaders of the European Union will face? 

MP: The parliamentary elections come at a time when the EU faces significant long-term challenges. Among these are geopolitical issues ranging from the war in Ukraine to the broader issues of whether the eurozone should enlarge to include neighbouring countries, and what the appropriate stance should be vis-à-vis countries like China or the Global South.  

More broadly, there’s the issue of regaining competitiveness for the EU and reviving the European growth model. This could mean stepping up the adoption of artificial intelligence (AI), for example, or ensuring a smooth and effective ‘green’ transition.  

These are big challenges, and they come on top of other long-term concerns such as the very unfavourable demographic trends hitting many European countries. All of these challenges require extra financing at a time when national budgets are already quite stretched.  

So, it’s quite logical and perhaps compelling for the EU to issue joint bonds. We saw the first round of joint borrowing in 2020 with the recovery fund, the so-called NextGeneration EU [fund]. At the time, EU leaders made it clear it was a one-off. Now we think this statement will likely be challenged. The question is whether there’s enough political consensus for issuing more joint debt.  

AC: Thank you, Mario, for joining me.  

MP: It was a pleasure being here.