Last week, the European Commission published new estimates for economic growth in 2019 and 2020. Brussels forecasts growth of 1,3% in the eurozone this year, compared to 1,9% previously forecast.
The above will undoubtedly contribute to the fact that the European Central Bank (ECB) will keep its monetary policy very loose for a long time to come. That is good news for the financial markets in the short term. However, the downside is that the budget deficits in the euro countries (without any intervention) will be higher than previously expected. This is because the estimates for income and expenditure were based on the assumption of significantly higher growth (and therefore higher income and lower government expenditure).
Tensions around Italy
In the light of the tensions between Rome and Brussels, the significant adjustment in growth prospects is potentially a major source of concern for the markets. For example, I do not see how the government in Rome can keep this year's deficit close to the agreed rate (2,04%) without interventions on the revenue or expenditure side.
However, there are 2 things that can ensure that tensions do not arise. First of all, these are the European elections of May 2019. The last thing Brussels wants is to blow wind in the sails of the populists. And to immediately demand various interventions from Italy, and in its wake from other countries, would have exactly that effect.
Secondly, the fact that Italy is in a recession also plays a major role. Although the recession is not (yet) deep enough to suspend European budget agreements for the country, experience shows that Brussels is so flexible that it will leave Rome alone for the time being.
Germany provides support
What could be beneficial for economic growth in the eurozone is that the German government may now be forced to fiscally stimulate the economy. In Germany, growth appears to be considerably lower than previously predicted. In recent years, Berlin has generally recorded a budget surplus or reached a budget balance. A fiscal stimulus in Germany would boost growth across the currency union.
If I put all that together, it wouldn't surprise me if speculation arises in the near future the ECB will start buying up corporate and government bonds (quantitative easing) again at the end of this year or next year. In addition, it would not surprise me if the LTRO counter for European banks remains open longer than previously assumed.
If the above happens, on balance, downward pressure on long-term interest rates in the euro zone can be expected in the near future. The above scenario would also be good news for eurozone banks.
Buy government bonds
Now that expectations about future monetary policy have been adjusted downwards, the strong euro countries are faced with low interest rates and the euro zone will rescue any euro country that gets into trouble, bonds from the weak euro countries (with attractive interest rates) seem to be in demand. With the prospect of lower growth and possibly monetary easing by the ECB, government bonds from countries such as Italy and Greece may rise in value. This explains the recent developments in the capital market.
Greece recently returned to the European capital market after years of absence. The country sold a 5-year bond at 3,6% without any difficulty and the issue was 4 times oversubscribed. This week, Italy raised €8 billion with a 30-year government bond at 3,85%. There was even interest in €41 billion. Last month, Rome borrowed €10 billion for a period of 15 years and investors missed out on an additional €25 billion.
Italy and Greece are normally the weakest links in the euro chain. The fact that they manage to raise money effortlessly and that the demand is much greater than the supply of bonds may indicate that the end of quantitative easing on December 31 last year has not yet had an upward effect on interest rates.
What to expect?
It is therefore understandable, based on the reduced growth estimates, that new tensions between Brussels and Rome are to be expected. However, the fact that Italy is currently in a recession may give Brussels sufficient reason to leave Italy alone this time. It should therefore become clear in the coming weeks what consequences the lower growth expectations will have.