OECD Economic Outlook, Volume 2018 Issue 1

Euro area

Economic growth in the euro area is set to continue at a relatively dynamic pace of just above 2 per cent over 2018‑19. Accommodative monetary policy, fiscal support and improving labour markets are supporting domestic demand, notably through dynamic private consumption. Investment is strengthening, on the back of favourable financing conditions, strong global demand and the need to expand capacity. Inflation is expected to strengthen gradually, as slack disappears.

Monetary policy should be firmly committed to remaining accommodative as long as needed to attain the inflation objective, while preparing for a gradual normalisation. The euro area fiscal stance is projected to be slightly expansionary in both 2018 and 2019. As the expansion consolidates, governments should improve their fiscal positions and reduce debt ratios. Improving skills, reforming product markets, completing the single market for goods and services, and progress with banking union, are the best guarantee for stronger and more inclusive growth.

The expansion continues

Dynamic domestic and external demand are supporting robust growth. Private consumption has slowed, as inflation has picked up, but remains resilient thanks to strong employment growth. Capital spending remains dynamic, supported by favourable financing conditions, robust demand and the need to replace obsolete capital. The recovery in residential investment is supported by favourable financing conditions and rising incomes. Despite a strengthening euro, trade growth was very strong in the second half of 2017 on the back of robust growth in Europe and the rebound in world trade, and has continued at a solid, even if slower, pace in the beginning of 2018. However, in the first quarter of 2018, high frequency indicators and quarterly GDP growth have softened, suggesting that the pace of growth has moderated somewhat from the high levels seen at the end of 2017.

Euro area

Source: OECD Economic Outlook 103 database.

Statlink

Labour market conditions keep improving. Unemployment has fallen to a nine‑year low. Labour force participation has increased in a number of countries, pointing to a healthy recovery in the labour market. Nonetheless, there have not yet been signs of strong real wage growth, despite improving labour markets. Despite dynamic growth, headline consumer price inflation remains moderate, held in check by the euro appreciation, as well as still remaining slack in labour markets. Core inflation remains soft.

Euro area. Demand, output and prices

Statlink

Reforms are needed to generate sustained improvements in living standards and strengthen resilience

In March, the ECB removed the explicit pledge to increase or extend asset purchases in its communication, which is appropriate given that deflation risks have receded and monetary policy will have to gradually shift to a less accommodative stance as the recovery continues. As inflation is set to progressively return to the objective of below, but close, to 2%, the ECB is projected to gradually reduce its monetary support. A cautious and gradual reduction of support is warranted in an environment of below‑target inflation and continuing labour market slack in many countries, and to avoid potential disruptions in financial markets. An upturn in inflation, as projected, will allow the ECB to reduce asset purchases from October 2018 and end them in December 2018, and then to increase the deposit rate by 25 basis points in the second half of 2019.

Euro area

1. Harmonised consumer price indices, net of energy and food products as for core inflation.

2. Nominal wages per employee.

3. Measured in per cent of potential GDP.

Source: OECD Economic Outlook 103 database.

Statlink

In the euro area as a whole, the fiscal stance is expected to remain slightly expansionary in 2018 and 2019. Public debt‑to‑GDP ratios remain above historical averages in many countries. As the recovery continues, governments should ensure that debt‑to‑GDP ratios fall significantly by improving fiscal positions further and by introducing structural reforms to strengthen growth. The credibility and effectiveness of the EU fiscal governance should also be strengthened with simplified fiscal rules. Continued progress to complete the banking union by creating a common fiscal backstop to the Single Resolution Fund, as well as an agreement on the European Deposit Insurance Scheme, remains key to strengthen the financial stability of the euro area banking sector and to enhance the resilience of the euro area.

Sustained improvements in living standards are held back by weak productivity growth and investment in many countries. There is ample scope for product market reforms to boost competition and enhance diffusion of new technologies in many countries. Faster implementation of Europe's digital single market and the swift completion of the single market in network sectors and services would foster investment and productivity growth. Investment needs are particularly important in trans‑European transport and energy networks.

Growth will remain strong

GDP growth is projected to average just over 2% per annum in 2018‑19, supported by accommodative monetary policy, some fiscal support and a recovering global economy. Private consumption growth will expand at a moderate, but robust, pace, benefiting from rising employment and stronger disposable income growth, as wages are expected to rise faster than in the past. The recovery in business investment is expected to continue, supported by favourable financing conditions and robust demand. Euro area export growth is expected to ease as foreign demand moderates. Inflation will gradually strengthen in an environment with higher oil prices, disappearing slack and higher wage growth. Policy uncertainty is high and could increase further. An escalation of trade tensions would undermine confidence, and eventually investment and trade. Brexit is not a major macro‑economic risk for the euro area as a whole; nonetheless, countries with the closest trade links to the United Kingdom could be severely impacted if the United Kingdom left the European Union without any trade agreement. High‑debt countries may have difficulties coping with higher borrowing costs if inflation surprises on the upside and monetary support is rapidly reduced. On the upside, the cyclical recovery in world trade or stronger confidence generated by on‑going momentum in solving euro area institutional weaknesses could lead to stronger than expected growth. On the other hand, calls to review and weaken the architecture of the European Union could undermine trust among member states, slowing down or blocking growth‑enhancing reforms in the EU.