FxWirePro: Eurozone Q4 Growth and CPI likely to end 2016 with expansion, but political risks begin to linger in H1’2017

Euro area GDP is expected to pick up in the final quarter of 2016. The underlying price pressures remain weak, but the latest economic data demonstrates that economic growth has remained moderate. Q3 GDP growth was 0.3% QoQ, the same as the prior quarter, and survey indications suggest that it will be stronger in Q4.

The euro area unemployment rate remains high, but it fell to a seven-year low of 9.8% in October, with employment growth supporting domestic demand.

Overall, we look for the euro area economy to expand by 1.6% in both 2016 and 2017. Risks to the economic outlook remain to the downside and they include the aforementioned political risks, as well as ongoing concerns about the Italian banking sector following years of economic underperformance.

There have, however, been few signs of any significant increase in domestic price pressures. Although euro area headline CPI inflation rose to a two-and-a-half year high of 0.6% YoY in November and is set to accelerate further as a result of energy price base effects, underlying ‘core’ inflation remained unchanged at 0.8% YoY and is actually lower than it was a year ago.

Overall, we expect headline inflation to accelerate from an average of 0.2% in 2016 to 1.4% in 2017, but it is not forecast to be sustained at the ECB’s goal of ‘close to but below 2%’ until 2018.

But on the contrary, political risks are clouded in euro area. Polls scheduled in Germany, France and the Netherlands. The euro area economy has so far weathered political surprises in the form of the UK’s referendum vote to leave the EU and the election of Donald Trump as the next US President.

Euro-area political indecisions would now be prevalent over the coming year, with key elections taking place in –

The Netherlands (15 March),

France (first round of the presidential election on 23 April and second round, if necessary, on 7 May) and

Germany (by 22 October).

Latest polls advise that the far-right Freedom Party may win the most seats in the Netherlands, although without a majority.

In France, the far-right candidate Le Pen is expected by commentators to make it to, but not win, the second round. An unexpected victory for Le Pen would call into question the EU project.

In Germany, the Chancellor Merkel is expected a victory for the fourth term, although the right-wing AfD party is a key wildcard.