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Economic Weekly…(Europe)

Sabado, 12 de Agosto de 2017 Redacción

Europe Economic Weekly: Self sufficiency is hard to learn • The current growth outperformance of the Euro area owes a lot to the policy mix, including fiscal but particularly monetary. • This 'self-reliance' is unusual. When policy support fades growth momentum may slow a bit.
•   Next week watch upside risks to Germany/Italy GDP (though momentum softening into 3Q) and what ECB minutes say on the euro.

Euro area self-reliant, but benign neglect on FX a risk

The last time the Euro area grew at or above 2% in annualized, as it has since Q4 2016, was late 2010. Back then both external and domestic demand helped (see Chart 1). Today, domestic demand is the only game in town: the Euro Area has become, for now, less of a black hole for world demand. This degree of outperformance probably won't last though, in our view. A reversal in the fiscal stance and QE helps explain virulent domestic momentum. But that combined policy push peaked in 2016. This is why we don't think that benign neglect on FX developments is warranted. We think much of the current strength in the euro is precisely a product of the current cyclical outperformance of the Euro area: the euro is strong "because" external demand is soft: a double-whammy. Meanwhile euro's gains relative to the ECB's assumptions could lower inflation and GDP by 0.3% in 2018 and more than 0.5% in 2019.

What to do then?

Sometimes, doing nothing is a desirable approach. It may well be that a bolder Fed reduces pressure on the euro. Though this would entail - and that's our central scenario - that the ECB waits until October before committing to the quantum of QE for next year, to take into account the Fed's September decision. We've made the point several times now that the central bank could try to shift focus to the likely policy rate path rather than QE. The recovery's reliance on stimulus calls for a very gradual and prudent approach to removing the monetary stimulus. The latest developments, even if the data flow in 1H has been stronger than we thought, leave us comfortable with our forecast for GDP growth in 2018 slowing down a bit from 2017 (1.7% after 1.9%).

Minutes and GDP next week

In our weekly view we preview next week's GDP prints - risks to the upside for Germany and Italy though momentum looks to be softening into 3Q - and the ECB minutes. Do they say more about the EUR than Draghi's guarded press conference comments?