Europe has added concrete to its recovery

Output gaps in Europe are large, but any recovery must begin with a single quarter of positive growth. Now the region now has a solid foothold to climb out.

The economic recovery in the eurozone is gaining breadth and momentum. There now seems little doubt that the eurozone is exiting a long and deep recession and that GDP growth is likely to lift to a decent pace in the next 12 to 18 months.

The eurozone’s GDP rose 0.3 per cent in the June quarter, with the big news being the stronger than expected growth rates in both Germany and France.

Germany’s GDP growth was 0.7 per cent in the June quarter, a rate that only just outpaced a 0.5 per cent lift in France. Both outcomes beat economist forecasts – again – and suggest that the expansion might soon start making inroads into the dreadful unemployment problem which has been evident over the past few years.

The better news for German and French GDP follows a period of six straight quarters where eurozone’s GDP has fallen. With the unemployment rate still at a record high 12.1 per cent, it is obvious that economic conditions are still parlous.

But every economic pickup must begin with a single quarter of positive growth and in the case of the eurozone it is increasingly clear that the June quarter 2013 will signal the start of such a recovery.

It was encouraging to note that the better than expected growth performance was aided by a lift in business and consumer spending, a trend that will need to be reinforced over the next few years for the economy to move to a more sustainable footing.

In recent weeks, there has been positive news in business surveys, consumer sentiment indicators and on-going strength in stock markets, all of which point to the strengthening in activity continuing into the second half of 2013. The current easy policy settings and relaxation of the increasingly discredited fiscal austerity measures have helped secure the turning point in the economy. 

There are still significant problems for some eurozone members. GDP fell again in Spain (down 0.1 per cent) and in Italy and the Netherlands (both down 0.2 per cent). Greece entered a sixth year of contraction (recession) and its GDP has now fallen by a cumulative 23 per cent since the crisis started.

Olli Rehn, the EU Economic and Monetary Affairs Commission welcomed the news, but was cautious in saying “for the next year, our projections show the recovery should be on a more solid footing, as long as we can continue to avoid new political crises and detrimental market turbulence”.

Clearly, the output gap in the eurozone is huge. The depth and duration of the recession means that the economy needs to grow strongly for several years before the spare capacity is close to being absorbed. Indeed, some estimates suggests that even three years of 2.5 per cent GDP growth, were that to be achieved, would still leave the unemployment rate only a little below 10 per cent. A period of very strong growth is needed to make meaningful inroads into the unemployment crisis. The European Central Bank is forecasting GDP growth of just 1.1 per cent in 2014, which highlights magnitude of the problems in the eurozone (New weeds choke Europe's green shoots, August 15). 

This suggests that monetary policy settings will remain easy for a long time to come, with the ECB maintaining its focus on doing “whatever it takes”, as Mario Draghi suggested last year, to lock in a sustained expansion.

At the latest ECB meeting earlier this month, interest rates were left at a record low of 0.5 per cent and it again flagged the notion that the weakness in bank credit growth left the door open for further interest rate cuts or even the possibility that rates could be negative if lending does not pick up.

Stocks throughout Europe were generally a little higher as the gloom slowly lifts with the major indices at or near record highs. Government bond yields continue to edge higher as the market delivered another positive assessment of the hopes for a recovery and the reflation of the otherwise depressed economic conditions.

The June quarter GDP result was hardly a sign of unrelenting strength in Europe but it did, finally, put some hard facts on the tentative news that had been building in recent months that the eurozone is recovering.