In January 2016, three of Pacific Investment Management Company's managing directors held a discussion on Europe's economic outlook and central bank activity, and a record of this discussion has been posted to the company's website. PIMCO expects modest growth in the United Kingdom and the eurozone, but issues with unemployment and economic output will continue to create disinflationary pressures, forcing central banks to maintain easy overall monetary policy. PIMCO forecasts a year of slow and steady improvement punctuated by periods of volatility.
1. Easy Monetary Policy Will Support Growth in Europe
According to PIMCO, continued fiscal stimulus by the European Central Bank (ECB) and negative nominal interest rates will spur demand for loans and keep gross domestic product (GDP) growth near 1.5%. The January 2016 bank lending survey by the ECB confirms these trends, citing reduced lending standards and an increase in quantity of loans demanded. However, actual lending data collected from December 2015 lending activity suggests that the conclusions from the bank survey may overstate the actual growth in activity. Fiscal policy should also help sustain growth, as government spending is expected to rise throughout several important European nations.
PIMCO expects inflation to rise from the 2015 level, but high unemployment and a wide gap between economic output and output potential make it unlikely that ECB inflation targets will be reached. A labor and productive capacity oversupply puts no upward pressure on prices or wages, creating an obstacle for inflation. Consumer price index measures of inflation have fallen below the targeted rate several years in a row, and ECB forecasts indicate that this trend is expected to continue through the next two years. Recently, inflation has occasionally fallen below 0% in Europe, which can have severe negative effects on growth. The negative nominal rates set by the ECB initially had a mixed effect, as banks struggled to facilitate loans due to profitability restraints in a negative rate environment. Early reports on euro inflation in 2016 indicate slight improvement, though it stands well below target rates. To ensure that the gap between actual and target inflation is not permanently widened, PIMCO suggests that continued expansionary monetary policy is necessary, and most commentators expect an extension of easy policy.
2. The Bank of England Is Likely to Raise Rates, Conditionally
PIMCO expects that a low 5.2% unemployment rate and healthy economic growth of 2% to 2.5% will prompt the Bank of England (BOE) to raise interest rates slightly this year. While growth would be used to justify a rate hike, sustained low inflation could create conditions in which less expansionary policy could be dangerous. PIMCO forecasts that annualization of low energy prices should ease disinflationary forces faced by the English economy. In the event that the United Kingdom votes to exit the European Union in a 2016 referendum on the topic, GDP could be threatened 1 to 1.5%, which would also decrease the likelihood that the BOE would tighten monetary policy.
3. Europe Will Have a Slight Positive Impact on the Global Economy
PIMCO expects that Europe will have a modest positive effect on the global economy in 2016. Positive GDP growth in one of the largest, wealthiest economic areas in the world represents a boon for demand everywhere, but 1.5% growth cannot be considered transformational. Europe can only offer marginal help as much of the world struggles to stave off disinflationary pressures. High unemployment and a wide output gap will continue to challenge efforts to meet inflation targets. PIMCO suggests that Europe will put a lower bound on global inflation, but little more. Political uncertainty could lead to economic volatility in Europe, particularly as people grapple with sustained economic stagnation, reforms in some countries, elections and the refugee crisis. PIMCO expects to continue quantitative easing and currency devaluation to provide support for security prices, but European and global threats, as well as reduced secondary market liquidity, could lead to alternating periods of stability and volatility.
