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KfW Business Cycle Compass Euro Area: Growth slows but remains on a high level

Press Release from 2018-09-07 / Group, KfW Research

  • KfW Research lowers growth forecasts for 2018 and 2019 to 2.0% and 1.7% (previous forecasts: 2.2% and 1.9%)
  • Growth in first half of 2018 has decreased by nearly half from 2017
  • Slowdown is not a harbinger of recession, business cycle remains strong
  • Forecast is subject to many downward risks

The pace of economic growth in the euro area weakened noticeably in the first half-year. Average quarterly growth rates were just under 0.4% on the previous quarter and thus only half as high as in 2017. While various special effects had slowed the growth rate at the start of the year, such as low temperatures that impaired construction activity, it is now becoming increasingly clear that the slowdown is not just temporary. Rather, the business cycle is set for a prolonged phase of more moderate growth. KfW Research has therefore corrected its growth forecasts for the euro area downward to 2.0% for 2018 (previous forecast: 2.2%) and 1.7% for 2019 (1.9%). Despite the slowdown, the euro area economy continues to grow at a rate that is higher than the long-term average.

“The slowdown is not a harbinger of a recession!”, emphasised Dr Jörg Zeuner, Chief Economist of KfW Group. “The economic indicators still signal a healthy business cycle.” The conditions for consumption are very good with a view to the labour market, wages and consumer confidence. With the economy running at full capacity the need for investment is high, and borrowing conditions remain good despite the ECB's gradual exit from its very expansionary monetary policy. International trade is the only area that is likely to face rough sailing for the time being. For one thing, the euro appreciated significantly between April 2017 and April 2018. The trend has reversed since then, but currency appreciations often take a while to affect growth. For another, further burdens on trade with the US through tariffs are off the table for now, but it is unclear whether that situation will last. In addition, the disputes between the US and other trade partners as well as Iran and Russia and the crisis in Turkey threaten to put the brakes on exports from the euro area. “The economy within the euro area is generally so stable that burdens from external trade will cause no more than a moderate downturn and growth rates this year and next will remain above average”, said Zeuner.

However, current growth forecasts are subject to a variety of downward risks which, if they materialise, may result in significantly weaker growth. These include a possible trade war between the US and China in particular, which would slow down growth not just through reduced trade volumes but mainly through heightened economic uncertainty and investment restraint. Tighter borrowing conditions for emerging market economies, triggered by more stringent US monetary policy, could lead to capital outflows and weakening economic activity in those countries. A hard Brexit without a succession agreement can still not be ruled out and will probably remain a possibility into the next year. Finally, within the euro area itself the danger exists that, depending on the Italian government's fiscal policy course, government bond spreads in the euro area will increase again and have a dampening effect on economic growth.

The current KfW Business Cycle Compass is available at:
https://www.kfw.de/KfW-Konzern/Service/Download-Center/Konzernthemen-(D)/Research/Indikatoren/KfW-Konjunkturkompass-Eurozone/

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