The recovery goes on, but at a modest pace and with marked disparities across countries. First-quarter growth picked up to 0.6% quarter to quarter, twice the rate of the previous trimester. Industrial production and retail sales improved through March. The advance estimates of PMIs show the pick-up might have continued into April. The euro-coin monthly composite by Banca d’Italia, however, showed negative momentum during Q1, so further improvement in Q2 cannot be taken for granted.
It is impossible to predict when Greece will get out of its toxic relationship with Europe
For the year as a whole, fiscal policy might be less restrictive than in 2015, removing a headwind. Despite the formal rules of the Stability and Growth Pact, Brussels has in practice been quite lenient on countries that exceed deficit targets.
Political factors, however, are unfavourable. The terrorist attacks in Brussels, the refugee crisis, and the impact of a possible Brexit might weigh heavily in corporate investment plans, at least through the first half of 2016. Spain, the Eurozone’s fourth economy, faces repeat elections in June, and current polls suggest none of the feasible coalitions will obtain a majority this time either.
Greece is likely to return to the front pages shortly. Looming in the horizon is a €3.5 billion debt repayment in July, which Athens can’t make without fresh bailout funds. The banks have been under capital controls that limit cash withdrawals for almost a year. Since then, Greece has nominally complied with demands for pension and tax reform, but its long-term fiscal outlook has barely changed.
Ahead of the July deadline there will be the usual wrangling between Germany and Greece—plus spats between Germany and the IMF, who wants to write off part of Greece's debt. If the summer crisis I anticipate is “solved,” it will be with another kick down the road; i.e. a new bailout in exchange for Greek concessions. If it’s not solved, it will be only because Greece slams the door. Greece's Prime Minister Tsipras almost did it last time. It is impossible to predict when Greece will get out of its toxic relationship with Europe, but it appears likely that eventually it will.
What Next for Inflation?
Inflation remains muted in the Eurozone. The European Central Bank expected headline price growth of just 0.1% in 2016. Oil prices will eventually determine where headline inflation winds up. But even core inflation, today around 1%, seems unlikely to be a concern for the ECB in the short term. In the medium term market-based inflation expectations are well below 2%.
Banking surveys suggest the ECB’s monetary policy is having a positive, although small, effect on the economy. Both supply and demand conditions are improving, and credit balances continue to grow, albeit slowly.
In the first quarter the ECB cut the deposit rate ten basis points, to -0.4%, and announced what is a de facto expansion of its unconventional policy arsenal: raising asset purchases from 60 to 80 billion a month; widening the range of assets eligible for purchase to include non-bank corporate bonds; and pushing out a new batch of long-term loans to banks. The ECB president also issued long-term guidance to the effect that interest rates will remain low for an extended period of time. No further loosening, however, is expected in the short term.
The ECB is planning to begin buying corporate bonds in July. While this could ease financial conditions through lower market interest rates, the corporate bond purchase program might have its biggest effect by improving the liquidity of these securities. At present, the European corporate bond market lacks depth: in 2015 issuance stood at $360 billion, versus $1.1 trillion in the U.S. If the ECB's purchases encourage more large corporations to issue bonds, banks might instead lend more to small- and medium-sized businesses.
