New Threats to Europe's Economic Recovery

For the first time in recent years, the European economy has managed to achieve a degree of economic stability that has allowed for the region to grow at a healthy pace over a prolonged period of time.  After a series of crises that resulted in a lost decade (and three recessions) for much of the region, there were fears that Europe was headed for long-term stagnation and decline along the lines of the situation that Japan has faced since the early 1990s.  However, a better performance by nearly all of Europe’s leading economies over the past three years has raised hopes that Europe can avoid a fate of long-term stagnation and decline.  In fact, Europe’s economy is healthier now than at any time in the past decade.  Nevertheless, threats, some new and some old, are emerging that will threaten Europe’s economic recovery in 2018 and the years beyond.

So far, Europe’s economic recovery has exceeded expectations, as few economists expected Europe to be able to reach the levels of growth that it has achieved over the past few years.  Of course, much of this growth is simply rebound from the dreadful performance of the European economy between 2008 and 2013, as it took Europe seven years to return to the level of economic output that it achieved in 2007, before the financial crisis hit the region.  Nevertheless, the overall European economy has expanded by an average of 2.1% over the past four years, an average rate of growth just below that recorded by the United States over the same period.  Much of this growth has been driven by exports, as the weakening of the euro and other European currencies during the early stages of this recovery was the key catalyst for the higher rates of economic growth recorded by most export-driven economies in the region.  After a period of stronger export growth, domestic demand levels also began to recover, helping to bolster the higher rates of growth that emerged in 2014 and 2015.  As a result, economic growth rates defied expectations by accelerating once again in 2017, allowing Europe to enjoy its most successful four-year period since the mid-2000s.

As Europe enters 2018, the level of economic optimism in the region is higher than it has been in a very long time.  Furthermore, Europe’s near-term economic outlook remains solid, and economic growth rates for 2018 are expected to remain near current levels.  However, a number of threats are emerging that could derail Europe’s economic recovery and lead to significantly lower rates of growth in the coming years.  First, Europe’s economic success is dependent upon its export competitiveness, and this is being eroded as the euro, the pound and other regional currencies have strengthened significantly in recent months.  Second, while demand levels remain relatively high in many key export markets, they could weaken in the months ahead, particularly in markets such as China.  Third, the stimulus programs put in place by the region’s central banks are gradually being withdrawn, and it is anything but certain that Europe’s economies can be as successful without these programs being in place.  Fourth, a great deal of political uncertainty will remain in place across Europe in 2018, with issues such as Brexit, the upcoming Italian election, and the lack of a new government in Germany all having the potential to severely weaken confidence levels in the region in the months ahead.

It appears that Europe’s economic recovery is at its peak, and that growth rates will not accelerate further in the months ahead.  While growth rates are forecast to remain near current levels in the first half of 2018, a gradual slowdown is likely to begin in the second half of the year.  Fortunately, a hard-landing for the European economy is not likely in the years ahead.  Nevertheless, a number of factors will determine whether or not Europe can continue to record solid rates of economic growth in the coming years.  For example, more must be done to stimulate domestic demand in Europe, something that is a difficult task considering the region’s challenging demographic profile.  Meanwhile, central banks, most notably the European Central Bank (ECB), need to ensure that the region’s currencies do not appreciate much further, as Europe will struggle to record significant economic growth without continued export growth.  For the moment, it appears that Europe will be able to avoid a period of prolonged stagnation such as that suffered by Japan over the past 25 years.  Nevertheless, even higher rates of long-term economic growth seem beyond the capabilities of most European economies at the moment, but given the struggles earlier in this decade, Europe would do well to prolong its current economic expansion.