Economics

TalkingEconomics: Europe forecast update - higher inflation to dampen growth

We have revised our eurozone growth expectations down slightly for 2017 but raised our forecast for 2018.

5 December 2016

Schroders Economics Team

In the UK, the Bank of England (BoE) is likely to remain on hold now given better growth, but the government has missed a great opportunity to boost public investment and long-term productivity growth.

We expect the European Central Bank (ECB) to resist calls to halt its stimulatory support and maintain its accommodative stance.

Our forecast for eurozone growth has been revised up slightly for 2016 from 1.5% to 1.6%. The 2017 forecast has been revised down to 1.2% as inflation is due to rise temporarily, from an annual average of 0.2% in 2016 to 1.3% (previously 1%) in 2017. We anticipate that growth will rise to around 1.8% in 2018, aided by looser fiscal policy, and stronger growth in the US, which should boost net exports.

ECB will have to defend its policy

We expect the ECB to hold firm in the face of rising pressure to scale back its stimuli programmes as inflation rises in the coming months. We anticipate that the deposit rate will be cut further to -0.5%, and that the authorities will extend QE for a further six months, with purchases tapering from Q4 2017 at the rate of €10 billion per month.

To extend the programme any further will be difficult but if it does, the ECB may have to look at its bond buying rules. A simple change in the share of issuance limits would help, or a move to buy equities (through exchange-traded funds) could also work, although the latter would be controversial.

UK forecast: counting the cost of Brexit

We have revised the UK growth forecast upwards for 2016 from 1.7% to 2.1%, and from 0.6% to 1.4% for 2017. Annual inflation is forecast to rise from 0.8% in 2016 to 2.9% in 2017, before easing back to 1.9% in 2018. The BoE is likely to remain on hold with regards to interest rates and QE for the foreseeable future.

Fiscal fumble: more slippage than a reset of policy

While the new UK chancellor has acknowledged Brexit’s negative economic impact, he has decided to continue to tighten fiscal policy, which may prove to be a hawkish mistake in years to come.

He has a very rare opportunity to provide badly needed investment in public infrastructure at close to zero interest rates, yet his cautious approach means the additional spending announced barely moves the dial.

The government has missed a great opportunity to use its balance sheet to boost investment and long-term productivity.

Important Information: This communication is marketing material. The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change.  To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.