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Outlook

We expect GDP growth to slow to 1.1% in 2019, and then grow by 1.3% in 2020 and 2021. Germany and Italy, the industrial hubs of the eurozone, will continue to suffer from the global manufacturing slowdown. So far, the domestic economy has remained resilient to the external slowdown and should continue to fuel growth. Tight labor markets, rising wages, and low inflation will support consumer spending. Investment is set to decelerate, but will still find support in high capacity utilization and low borrowing costs. Given the downside risks to growth, the ECB will wait until at least the second quarter of 2021 to raise rates, keeping the euro weak.

Risks

Risks to growth are tilted to the downside. An escalation of trade disputes, which could mean higher tariffs on EU cars, and a hard Brexit would all weigh on growth. On the positive side, the ECB's likely new stimulus package would support financing conditions.

 

 

 

 

Germany

State of play

In the first quarter, the German economy rebounded by 0.4%, after remaining flat in the fourth quarter of 2018. Domestic demand was the main growth driver. The labor market is strong and unemployment has reached an all-time low of 3.1%. Accelerating wage growth supports household consumption, while investment largely stemmed from the booming construction sector. Only half of investment could be classified as productive. After a rebound in the first quarter, exports decreased in April, hinting that external trade weighed on growth in the second quarter. The dichotomy between strong internal and weak external demand persists. Although slightly up in June, manufacturing PMI remains in contractionary territory and a further fall in factory orders points to weakness in industry.

Outlook

We expect German economic growth to remain subdued amid weaker global trade, especially Chinese demand for equipment goods and cars, and heightened uncertainty. We forecast expansion of 0.6% this year and 1.1% in 2020. Given the economy's dependence on its highly export-oriented manufacturing sector, a slowdown in external demand will continue to weigh on growth. Household consumption, supported by a strong labor market and dynamic wage growth will remain the main driver of growth. Weak external demand and uncertainties around the trade outlook will also depress business investment. This will exacerbate Germany's long-term problem of underinvestment and constrain economic activity once demand accelerates again.

Risks

Main risks are external, notably a hard Brexit and an escalation of trade tensions, such as the introduction of U.S. tariffs on EU cars.

France

State of play

In the first quarter, the French economy slowed only marginally, to 0.3% from 0.4% in the fourth quarter. Domestic demand propped up growth as external demand was weak against a backdrop of slowing global trade. The data available so far suggests growth is likely to have remained stable at 0.3% in the second quarter. France is one of the bright spots in the eurozone. Sentiment surveys have rebounded across the board, reflecting resilience in economic activity. Consumer confidence has recovered from the yellow vests protest and is now at a 12-month high and the PMI in both industry and services is back above 50. In this environment, the labor market is tightening further. The unemployment rate reached a 10-year low at 8.6% in May and wage growth was above 2%, boosting household consumption.

Outlook

We expect French GDP to grow by 1.4% in 2019 and 2020. The resilience of the domestic economy will continue to underpin growth. Good job creation, rising wages, the government's fiscal support, and low inflation all support household spending. Firms' investment is set to remain dynamic as they continue to benefit from tax cuts and low borrowing costs. They still report a high capacity utilization rate. Meanwhile, there are few signs that the weakness in global trade is receding. Yet, unlike its neighbors, France's internal forces are likely to offset this external weakness. Household real disposable income is rising at its fastest pace since the financial crisis and faster than household spending, suggesting consumers have more space to loosen their purse strings.

Risks

On balance, most of the risks to growth are external. Global trade tensions could intensify and the outcome of Brexit remains unclear. On the upside, the ECB is likely to unveil more monetary policy easing, which would boost investment and construction.

Italy

State of play

Although the economy grew by 0.1% in the first quarter of 2019, this was not enough to offset the two preceding quarters of economic contraction. Domestic demand and net exports both contributed to growth, but the economy largely remains in stagnation. Household consumption was subdued, although net trade improved due to a moderate rise in exports and a 1.5% drop in imports. The latest surveys do not bode well for the second quarter. Manufacturing PMI remained in contractionary territory and the Istituto Nazionale di Statistica's measures for both business and consumer confidence were at multi-month lows in June. In April, industrial production fell for the second consecutive month and retail trade was flat.

Outlook

We expect Italy's economy to barely expand, with GDP growth of 0.1% in 2019 and 0.5% in 2020. External demand is likely to remain weak and the industry will continue to suffer from the global trade slowdown. Domestic demand will support growth to some degree. Employment is stable, despite economic stagnation, while wages are still rising relatively rapidly. In 2019, consumers will benefit from low inflation and the government's fiscal loosening. That said, investment is set to decelerate amid tighter financing conditions and weaker demand. In the longer term, low productivity will constrain growth, given that reforms are not on the table.

Risks

Apart from uncertainty surrounding global trade relations, the length of the global manufacturing slowdown, and Brexit, uncertainty over government policy remains a risk to growth. Given high government debt, Italy does not have much room for maneuver.

United Kingdom

State of play

Surprisingly strong growth in the first quarter of this year, with GDP up 0.5%, continued to be underpinned by strong private consumption, as households continue to tap into savings to support spending. Activity was also characterized by extraordinary stockpiling in the manufacturing sector, which would normally boost GDP. But because extra stocks were largely imported, the combined contribution of stockbuilding and net exports was actually a drag.

Outlook

Although we expect net exports to recover in the second quarter, they will be constrained a generally weak external environment. Destocking in manufacturing will weigh on growth, with not much help from the much bigger services sector. Meanwhile, investment is still paralyzed by Brexit uncertainty. In fact, the economy could contract in the second quarter before returning to moderate growth thereafter. That said, the strength of the labor market and the ongoing rise in real incomes will make it possible for households to further increase spending and, hence, drive economic growth.

Risks

Our forecast reflects our view that the U.K. will not leave the EU without a deal and the transition phase it would trigger. Following the resignation of Prime Minister Theresa May and a likely more eurosceptic successor, downside risks to our forecast have increased. While a possible entrenchment of pessimism regarding trade across the world adds to the risks, a disruptive no-deal Brexit, whose risk which we see as high and worsening, continues to dominate.

Switzerland

State of play

Swiss GDP growth rebounded strongly to 0.6% in the first quarter of 2019, after rising modestly in the second half of 2018. External and domestic demand supported growth in the first quarter, while destocking weighed on growth. High-frequency data points to a moderation in growth in the second quarter. In June, manufacturing PMI was at its lowest level since 2012, and consumer and business sentiment weakened further. Retail sales also declined by 1.5% in May. Capacity utilization is now below its long-term average. Besides the global slowdown in manufacturing, the Swiss franc is now at its highest level in two years, hitting exports.

Outlook

We forecast GDP will increase by 1.3% this year and 1.4% next. Ongoing weakness in manufacturing globally is set to further weigh on growth this year, especially as the Swiss franc remains strong. As a result, investment is set to slow. That said, household demand remains resilient. The labor market is still creating jobs and lower inflation this year will continue to support household income and spending this year. The Swiss National Bank is unlikely to precede the ECB in monetary policy normalization, especially amid upward pressure on the Swiss franc. Therefore, we expect the first hike to be in the second quarter of 2021. The bank will, however, retain intervention in foreign exchange markets as its main policy tool.

Risks

Current tensions with the EU could start affecting the economy if it starts endangering access to the single market. The economy would also suffer from escalating global trade tensions through the manufacturing sector and upward pressure on the currency.

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Sources: Standard & Poor's Rating Services and Eurostat.
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