Euro: Growth Still Missing

Consensus Forecasts

The euro headed south during the second half of June and into early July, slipping below €1.29/US$ as the US dollar strengthened on expectations of higher rates (page 3). While the worst of the debt crisis has passed, the euro zone remains fragile. Austerity tensions in Greece and Portugal continue to raise the risk of wider instability, while political stresses in Italy and France have frothed due to high unemployment and a lack of growth (with both in recession), as well as concern about low levels of productivity and structural reforms. Even Germany, which narrowly avoided two consecutive quarters of decline in Q1, has stumbled on regional weakness as its exports slumped in May. The European Central Bank kept rates unchanged at 0.5% last week and signalled that borrowing costs will be held at a low level “for an extended period”. Critics noted this dovish policy statement, which was undoubtedly intended to let investors know that the governing council is on a different monetary timetable than the US Federal Reserve. An uptick in long-term rate expectations across Europe in recent months (despite economic weakness and relatively low inflation) have added uncertainty about the recovery path. Certainly, heavily-indebted states and overleveraged bank balance sheets could threaten to destabilise investor sentiment and make it difficult for the euro zone as a whole to recover from its current stagnant position.

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