Eurozone: Low Inflation and Political Risks Take Centre Stage – Goldman Sachs

Research Team at Goldman Sachs, suggests that the net effect of the recent market volatility on Europe’s growth outlook is likely to be relatively small in our assessment, with the boost to growth from lower oil prices offsetting the hit from weaker equity prices and a stronger Euro exchange rate.

Key Quotes

“However, the downside risks relative to our central (modal) growth forecasts have increased materially. Three risks, in particular, are worth highlighting: first, the slowdown in the global industrial cycle appears more pronounced than we had previously anticipated; second, the increase in the credit spreads of European banks threatens to de-rail the easing in domestic credit conditions that is underway; and, third, the political risks presented by the UK’s EU referendum on 23 June and by Europe’s ongoing refugee crisis continue to pose a threat to Europe’s economic outlook. We continue to monitor each of these risks closely.

While our (modal) growth forecasts have been broadly unchanged since our last quarterly forecast update, we have made significant downward revisions to our near-term inflation forecasts in reaction to the fall in oil prices and the rise in the Euro exchange rate.

Responding to the weakness in near-term inflation dynamics, we expect the ECB to announce a number of additional easing measures at its 10 March meeting, including a 10bp cut to the deposit rate, a €10bn per month increase in the rate of asset purchases and a six-month extension of the Asset Purchase Programme (APP) to September 2017. Outside the Euro area, the sharp fall in oil prices and the associated weakness of near-term inflation are also driving monetary policy prospects.

We expect the weakness of inflation and the increase in political risk across Europe to dominate market sentiment in the coming months.”