KfW Business Cycle Compass Euro Area: Headwind hits economy

• Problems in automotive industry with new emissions testing standard were special factor weighing on third quarter
• KfW Research lowers its growth forecasts for 2018 and 2019 moderately to 1.9% and 1.6% (previous forecasts: 2.0% and 1.7%)
• List of economic risks remains long

Euro area economic growth disappointed again in the summer. With an increase of just 0.2%, the third quarter was one of the weakest since the start of the recovery in 2013. Just as in the previous quarters, economic performance was significantly burdened by a temporary special effect. After inclement weather, an influenza wave and strikes in the first half, now it was the automotive industry's problems converting to the new WLTP approval and emissions testing protocol by the beginning of September, which slowed economic activity all across Europe. As a result, nearly 6% fewer vehicles rolled off the assembly lines in the euro area than in the three months before. Automobile production should recover again by spring 2019. On the basis of the weak third quarter, KfW Research has moderately revised its growth forecast downward to 1.9% for 2018 and 1.6% for 2019 (previous forecasts: 2.0% and 1.7%).

"The European economy remains on a growth path. Although the signs are pointing to a cyclical slowdown, I remain optimistic that we will continue to see clearly positive growth rates. Domestic demand must – and can – sustain the growth", said Dr Jörg Zeuner, Chief Economist of KfW.

The fundamental conditions for a solid expansion of private consumption in the euro area remain intact. Unemployment is on a ten-year low, and real wages are growing at a decent rate and should receive a boost from falling energy prices in the short term. High capacity utilisation shows continuing need for investment. And despite the slow reduction in monetary policy support, financing conditions for enterprises should remain favourable. Furthermore, fiscal policy in 2019 will add impetus of just under 0.5 per cent of gross domestic product to bolster the business cycle.

Still, the list of economic risks remains long, and the three main downward risks for the European economy are unchanged. First, the trade conflicts can escalate at any time. Second, a disorderly Brexit cannot be ruled out until the British Parliament has given its approval to the withdrawal agreement, which is anything but certain. Third, Italy is threatening to slip into a downward spiral fuelled by rising risk premiums, shaky banks and declining growth as a result of the new government's plan to loosen fiscal policy.

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