Data Points To Higher Growth
The growth outlook for the eurozone remains solid following the latest data release which saw the first estimate of Q3 growth coming in above expectations at 0.6% while Q2 growth was revised higher from 0.6% to 0.7%. Given the continued strength shown in business surveys, Q4 GDP is expected to show growth also. A further print 0f 0.6% would see 2017 growth sitting at around 2.4% on the year, marking its strongest performance since 2007.
Indeed, over recent months, the majority of economic data points out of the eurozone have highlighted economic strength. The EC sentiment indicator hit levels in October not seen since 2001, along with the highest level of industrial confidence since the creation of the euro. PMIs have also remained firm, hitting highs in November not seen since 2011, with manufacturing leading the pack. New orders have also moved to multi-year highs as work continues to increase, highlighting growing capacity pressure. Given this continued data strength it seems reasonable to judge that there are upside risks to the eurozone growth outlook which, should see the EUR upside amplified.
Household Consumption Strengthening
A key source of economic growth, which is likely to continue and strengthen, is household consumption, fuelled by an increase in disposable income as stronger consumer confidence and still-supportive credit conditions keep consumers spending.
The consumer driven recovery has also filtered into the business sector with corporate profitability benefiting from debt stabilisation and lower lending rates, alongside accommodating tax measure in some countries.
Furthermore, the pickup in global growth and global trade since Q3 2016 has also fuelled a surge in euro exports, buoyed by better EU growth and a rise in emerging market economies. Indeed, global growth rose over the summer at a pace not seen since 2010 and is expected to rise at around 4% over 2018, with only a slight pullback in 2019 due to the maturation of the cycle.
Political Risks Not Affecting Growth
Importantly, growth in the Eurozone has, so far not been affected by political risks which have boiled over at times. Despite the result of the Catalan independence referendum and the state’s unilateral declaration of independence, the economic implications have been contained to date. The base case scenario is for the upcoming December 21st elections to renew the Catalan parliament, which should then see a negotiation between them and the Spanish government. This will be regarding reformation of the regional financing system and public infrastructure, in a bid to satisfy those of the pro-independence camp’s demands.
In Germany, Chancellor Merkel is still fighting to form a government, two months on from the September general election. The failure of initial talks aimed at creating a “Jamaica coalition” has led to new talks aimed at securing a grand-coalition with the SPD. These negotiations are likely to continue into 2018, prolonging the political stalemate and the prospect of a renewed grand-coalition that would simply see the status quo maintained.
A similar stale mate is likely to result from the Italian elections to be held in 2018, as current polling suggests that no party will gain an outright majority, resulting in a hung parliament. The only visible risk to the Eurozone in this situation would be if a coalition is formed among the anti-establishment and anti-euro parties.
The risks around Brexit have subsided also as it now appears increasingly likely that the UK will secure a mutually beneficial deal with the EU allowing for a smooth transition out of the eurozone. Last week’s breakthrough regarding the divorce bill encourages this view and the market now waits for the proposal to be signed off at this week’s EU summit.
For now, EURUSD is sitting in a bull flag formation just above the 2015 high at 1.1710. While above this level, focus remains on further upside with a break of the flag seeing a run up to the 2017 high as its first objective. The risk to this is if the FOMC meeting this week is more hawkish than expected, which could temporarily force the EUR down below the level and to the bottom of the bull flag.