TalkingEconomics: Eurozone growth upgraded as UK slows on Brexit fears

Better-than-expected growth numbers out of Europe have lifted sentiment, but disappointing inflation data suggest there is still a long way to go. Meanwhile, the UK's upcoming referendum on its membership of the EU appears to have hit confidence and slowed growth.

1 June 2016

Schroders Economics Team

Eurozone forecast: brighter outlook

Robust GDP growth at the end of 2015, combined with the upside surprise seen in Q1, means we are upgrading our growth forecast.

We now expect growth to accelerate to 1.8% year-on-year by end-2016, before moderating again to 1.6% over 2017. However, we have lowered our headline inflation forecast from 0.7% for 2016 to 0.5%, and from 1.6% for 2017 to 1.2%.

We continue to expect inflation to improve over the rest of the year as the drag from food and energy prices fall out of the annual comparison, but believe headline inflation may peak at a lower level: sub 1.5% in 2017.

The outlook for monetary policy is largely unchanged. We suspect the European Central Bank (ECB) will favour another cut in the deposit rate (assumed cut to -0.5% in September), although an extension of the ECB's quantitative easing (QE) programme to beyond March 2017 is also possible.

UK forecast: Brexit distortions

The UK economy saw a sudden slowdown in activity in Q1, which we believe is likely attributable to concerns about Brexit risks. We forecast a greater slowdown in Q2, but then a sharp recovery in Q3 (assuming the UK votes to remain in the EU on 23 June), followed by moderation from there on.

Taken together with the upward revisions seen to the GDP figures for the second half of 2015, we find our forecast unchanged at 1.9% for 2016. Growth in 2017 is expected to slow to 1.6% as the government aims to step up fiscal austerity.

The Bank of England (BoE) is expected to raise interest rates in November to 0.75%, as the economy rebounds after the referendum, and inflation returns above the BoE's lower target of 1%. We anticipate that the Bank will then raise again in February 2017 to 1%, before being forced to stop as the economy slows.

The above forecast is highly dependent on the UK voting to remain in the EU. A vote to leave would hit business and consumer confidence, causing a slowdown in growth, a fall in sterling and a rise in inflation. As things stand though, the likelihood of a vote to leave the EU is falling according to betting markets.

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