Market signs indicate borrowing costs will stay low for years

GDP for the opening quarter of 2016 showed the eurozone economy expanded solidly — up both from the previous quarter and on an annual basis.

Other data for the quarter suggest the economy was boosted by strengthening consumer spending and industrial production, amongst other factors.

Retail sales grew by 0.7% in the eurozone in the first quarter, up from the 0.2% rise in the previous quarter. The underlying data point to a relatively broad-based improvement in spending in early 2016.

In the meantime, industrial production rose by 0.9%, compared to a 0.4% increase in the final quarter of last year. 

Notably, though, monthly data suggest that external trade may again have had a modestly negative impact on growth in the first quarter.

In terms of the performance of the economy so far in the second quarter, leading indicators of activity have generally pointed to continued moderate growth. 

The Markit Composite Purchasing Managers’ Index (PMI) averaged 53.1 in April and May, virtually unchanged from 53.2 in the first quarter. Likewise, the EC economic sentiment index averaged 104.4 in April and May, compared to 104 in the first quarter.

Meanwhile, national level indicators, such as the German Ifo, French Insee, and Italian Istat indices all point to moderate growth in the last couple of months.

Improvements in the economy are being reflected in the labour market.

The unemployment rate fell to 10.2% in April, the lowest for four and half years. While the figure does hide significant differences — Germany’s unemployment rate of 4.2% compares with rates of 9.9% in France and 20.1% in Spain — the gap between eurozone countries has narrowed somewhat in recent months.

The year-on-year growth in employment continued to accelerate in 2015, reaching a seven-and-a-half-year high of 1.2% by the end of the year. 

In terms of 2016, the eurozone composite employment PMI index has been broadly stable so far this year, holding at around its end 2015 levels.

This suggests that employment should have continued to grow at a moderate pace in the first half of 2016.

Monetary aggregates were much improved last year and this trend continued in the opening months of 2016. 

However, year-on- year growth in M3 money supply slipped to 4.6% in April from 5% in previous months.

Meantime, the pace of growth in lending to the private sector edged up to 1.1% year-on-year in April, although there are few enough signs yet of any real upward momentum in credit expansion. Overall, growth in the eurozone is expected to remain moderate in a range between 1.5% and 1.75%.

The economy still faces some significant challenges. These include high levels of unemployment in many countries, a lack of structural reforms in some economies, the negative impact from a slowdown in growth in emerging markets, as well as the potential for negative geopolitical developments and the present uncertainty over the UK’s EU referendum.

However, there are also positives for the economy, including the favourable impact from lower commodity prices, a weaker euro and the impact of monetary policy easing, with interest rates likely to remain at very low levels for the next few years.

The ECB’s Governing Council met last week and, as expected, ended with no changes to monetary policy, maintaining its key deposit rate at minus 0.4%. 

However, the ECB again emphasised its willingness to loosen policy further, if necessary.

It also said it expects “interest rates to remain at current or lower levels for an extended period of time”.

In our view, with inflation in the eurozone expected to rise from the second half of the year onwards and the economy now on a steady, if moderate, growth path, rates may well have reached a trough, unless there is a major shock to the economy and financial markets.

Nonetheless, it could take a number of years before inflation returns to the ECB’s target rate of just below 2%. 

Thus, as the ECB has indicated, interest rates are set to remain very low for quite some time. Indeed, futures contracts suggest money market rates in the eurozone will remain negative for the rest of this decade.

* Oliver Mangan is chief economist at AIB.


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