Europe: It's Not That Complicated


The strategy surrounding our European outlook is not all that complicated: it boils down to a story of deleveraging and the macroeconomic adjustment process that goes along with it. From a bird’s eye view of Europe, we see a deleveraging process that is ongoing amid a banking system with a still elevated stock of non-performing loans, especially in the corporate sector. That is why we expect growth to slow down from 1.5% in 2016 to just 1.4% in 2017. While recent data pushed us to upgrade slightly our forecast for 2017, due to the cyclical upswing in the global manufacturing cycle, the expected recovery over the medium-term is too slow to sustainably move inflation to the European Central Bank’s (ECB) policy target.

What is complicated is the political manifestation that is rearing its head in European policymaking, fiscal and monetary policy alike. The German economy is performing well, yet bounds of negative rates have been met within the German banking system, for example, making the regional policy stance inappropriate for Germany at the country level. As the regional voices of the Governing Council boom, monetary policy is likely to be made on a country-country summing to the whole consideration, rather than a top-down regional decision. This will push the ECB toward a suboptimal policy path over the next year and a half, with more tightening of financial conditions than is economically justified. Furthermore, with little chance of stimulus coming from German Chancellor Angela Merkel’s grand coalition, we are concerned that easing fiscal policy of 2016 will no longer be supportive moving in 2018.

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