Economics

Eurozone: Springing into recovery

Europe's economy is on the road to recovery, according to Schroders European Economist Azad Zangana, but equity and bond markets could still see some volatility in the coming months as Greece continues to negotiate its next bailout.

04/05/2015

Azad Zangana

Azad Zangana

Senior European Economist and Strategist

Europe is getting back on track. The unclogging of the banking sector marked the turning point for Europe last year, but combined with falling oil prices and quantitative easing, the economy is outperforming expectations.

Meanwhile, Greece is nowhere nearer to agreeing the terms of its next bailout, raising the likelihood of a forced exit from the eurozone.

Despite this, peripheral markets have seen little contagion. We ultimately expect an agreement to be reached, but see limited market impact if Greece decides to go it alone.

European recovery – take two

After a miserable 2014, the eurozone is finding its feet once again with macroeconomic data surprising consistently to the upside.

We believe the turning point for Europe was the end of the asset quality review (AQR) last year. With banks no longer focusing on building up capital reserves in anticipation of the review, the sector has resumed normal lending activity and we expect this to continue to build this year.

Further support for the economy has been found in the lower oil price which has helped lift disposable income and boosted spending elsewhere in the economy.

Room for optimism

We see a further two reasons for optimism about growth.

Firstly, the weaker euro should increase demand for eurozone exports (as these become cheaper in local currency terms in foreign countries) and reduce demand for imports (as imports become more expensive in euro terms compared to domestically-produced goods).

The improvement in net trade will not be noticeable at first, but should begin to contribute to growth over the coming years.

Secondly, as firms become more confident about the sustainability of the recovery, they will begin to rebuild inventories which could contribute 0.25%-0.5% to GDP over the coming four to six quarters.

Greece saga rumbles on

Greece is still no nearer to its next bailout agreement and the economy is facing increasing pressure on multiple fronts: tax revenues have collapsed, and households and corporates are withdrawing savings at a considerable pace.

Although the likelihood of a Greek exit from the monetary union has risen, our central view remains that Greece will remain in the eurozone, either through a change in government or an eventual capitulation to the demands of the Troika (which comprises the European Union, European Central Bank and International Monetary Fund).

We expect additional volatility in European equity and bond markets in the next month or two. However, we ultimately expect a deal to be reached, and failing that, contagion to other peripheral markets to be limited.