Perspectives

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EcoPerspectives // 4 quarter 2018  
economic-research.bnpparibas.com  
Eurozone  
The long road to normalisation  
Growth has been moderating in 2018, although remaining above potential. Prices pressure are increasing as signalled by high levels  
of capacity utilisation, declining unemployment and rising wages. As underlying inflation is projected to move towards the ECB’s 2%  
ceiling, the central bank decided to reduce net asset purchases and possibly halt them from January 2019. Policy rates will remain  
unchanged at least through the summer of 2019. The policy mix should stay expansionary and GDP growth may moderate towards its  
trend rate in 2019.  
1- Growth and inflation  
Growth moderation in 2018  
GDP Growth (%)  
Inflation (%)  
Although the growth momentum has moderated in 2018, the  
eurozone continues to experience above-potential growth. Capacity  
utilisation rates are at a record high and in some areas production is  
even held back by capacity constraints. Companies increasingly  
report shortages of skilled labour, as unemployment has been  
trending down. In August, the unemployment rate reached 8.1% and  
the output gap is close to zero.  
Forecast  
Forecast  
2.5  
2
.0  
1.9  
1.9  
1.9  
1.9  
1.5  
1.5  
In the first half of 2018, the economy grew on average by 0.4% per  
quarter. Business cycle indicators point at a similar pace for the rest  
of the year. The recovery is broad-based. The ECB’s monetary  
policy measures continue to underpin domestic demand. The  
investment climate has improved thanks to favourable financing  
conditions and improved corporate profitability. Low interest rates  
and rising prices are stimulating new housing construction.  
Moreover, private consumption is supported by the favourable  
employment outlook, partly as a result of past labour market reforms,  
and growing wages. In addition, exports are supported by the still  
rapid expansion of world trade and the relatively cheap euro.  
0
.2  
0
.0  
1
5
16  
17  
18  
19  
15  
16  
17  
18  
19  
Source: Eurostat, BNP Paribas  
2
- Strengthening price pressures (%,y/y)  
labour cost index  • • GDP deflator  
 consumer prices (ex. food and energy)  
4
%
The flatness of the Phillips curve  
3
2
1
0
Even though activity is close to potential, consumer price inflation  
has remained rather subdued. In September, largely due to higher  
energy prices, consumer prices were 2.1% higher from a year  
earlier. Core inflation amounted only to 0.9%, 0.1 percentage point  
lower than in the previous month.  
The lack of response of labour market pressures to prices is  
observed in most of the advanced economies. The Phillips curve,  
the relation between unemployment rate and wages, seems to have  
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006  
2008  
2010  
2012  
2014  
2016  
2018  
1
flattened. Various factors, such as the lowering of the structural  
unemployment rate, weak inflation expectations and the decline in  
wage bargaining power, have been suggested as explanations. In  
our approach, a long-term relationship between labour productivity  
and wages is assumed. In the immediate aftermath of the great  
recession, labour productivity sharply declined because employment  
and wages did not adjust immediately to the output deterioration.  
Employers were reluctant to lay off workers and workers did not  
accept outright pay cuts. The process to bring wages again in line  
with productivity has been achieved by close to zero wage growth  
Source: Eurostat, OECD, BNP Paribas  
and losses in purchasing power. This process has taken a long time  
to complete, as low wage growth also slows production costs and  
inflation. However, since 2016, wage growth has been accelerating  
again. In Q2 2018, compensation per employee was 2.3% higher  
from a year earlier.  
End of asset purchase programme  
Price pressures have been strengthening, as signalled by high  
levels of capacity utilisation, declining unemployment and rising  
wages. If persisting, these pressures are likely to be translated into  
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See Jean-Luc Proutat, Eurozone: The hypothetic return of inflation, BNP  
Paribas EcoFlash, 14 September 2018.  
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EcoPerspectives // 4 quarter 2018  
economic-research.bnpparibas.com  
higher sales prices. In our inflation scenario, core price inflation is  
slowly accelerating, reaching 1.7% by end 2019. Also the ECB  
scenario projects headline inflation to converge to the bank’s  
medium-term objective, below but close to 2%.  
3
- Investors brace for budget clash between Italy and EC  
5
-year Treasury constant maturity rate  
Italy ---Spain  France  Germany  
5
%
On this basis, the ECB decided at the September meeting to reduce  
the monthly net purchases to EUR 15 billion, from October until the  
end of December, compared with EUR 30 billion before. If incoming  
data confirm the ECB’s medium-term inflation outlook, these  
purchases would be halted completely next year. In that case, the  
ECB only reinvest maturing securities in its portfolio for as long as  
necessary to maintain favourable liquidity conditions and an ample  
degree of monetary accommodation. By reinvesting maturing  
securities in long-term securities, the bank will still be able to  
influence the yield curve over a wide spectrum.  
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3
2
1
0
-1  
2
013  
2014  
2015  
2016  
2017  
2018  
In addition, the ECB wanted to tie the expected path of policy rates  
to prevent undue tightening through an increase in short-term  
interest rates after ending the asset purchase programme. Hence, it  
introduced a two-leg conditionality of guidance: interest rates are  
expected to remain at their present levels at least through the  
summer of 2019 and in any case as long as necessary to ensure  
the continued sustained convergence of inflation towards the central  
bank’s objective. The communication was successful insofar the  
financial market reaction was aligned to the ECB council decision.  
As a first step, we expect the bank to raise its deposit rate in  
September 2019 from -0.4% to 0.2%. As a second step, the  
refinancing rate could be raised in 2020.  
Source: Thomson Reuters, BNP Paribas  
The recent confrontation between Italy and the European  
Commission on the breaching of EU budget rules demonstrates the  
difficulty in finding common ground even on a limited reform agenda.  
Raymond Van der Putten  
raymond.vanderputten@bnpparibas.com  
The macroeconomic policy mix should remain supportive to growth  
in the coming quarters. In particular, domestic demand should  
remain resilient and offset some to the external headwinds such as  
Brexit and US trade tariffs and other protectionist measures. Growth  
is expected to moderate towards its trend rate in 2019.  
Eurozone reforms in an impasse  
In the longer term, reforms will be necessary to improve the stability  
of the single currency area. Eurozone leaders have been hoping to  
make progress in the run-up to the 2019 European elections. The  
intention was to make already some concrete decisions at the  
summit in June. In the end, most of the meeting was taken up by  
migration policy. The issues concerning eurozone reform were  
pushed on the agenda of the December meeting.  
In June Germany and France presented their common vision in the  
so-called Meseberg declaration. Both countries agree in principle on  
the importance of completing the banking union, making progress  
on the capital markets union, transforming the ESM into a European  
Monetary Fund and introducing a Eurobudget by 2021. However,  
they differ on the scope of these reforms and their implementation.  
Moreover, these principles are not shared by all European countries.  
A group of eight smaller northern European countries headed by the  
Netherlands argue that EMU reforms should involve all the EU27  
countries. Moreover, they should focus on a less ambitious  
programme, such as completing the banking union, improving  
compliance with the Stability and Growth Pact and setting up a  
European Monetary Fund.  
QUI SOMMES-NOUS ? Trois équipes d'économistes (économies OCDE, économies émergentes et risque pays, économie bancaire) forment la Direction des Etudes Economiques de BNP Paribas.
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