MNI INTERVIEW: ECB Growth Forecasts Over-Reliant On China

Recent upward revisions to European Central Bank’s growth forecasts are dangerously reliant on optimistic assumptions about trade with China, a former senior Bank of France official told MNI.

Eurosystem staff projections for 2023 growth rose from 0.5% last December to 1.0% in March, a revision Laurent Ferrara, deputy head then head of the International Macroeconomics division at the Banque de France from 2010-2019, described as “huge” and “surprising” given that household consumption forecasts were not changed, while business investment was revised downward

External demand was revised positively from 1.2% to 2.1%, which Ferrara, now professor of International Economics at SKEMA Business School and head of II Forecasters, attributed principally to the “really strong assumption” that global growth will improve from a projected 2.6% to 3% thanks to China’s post-lockdown reopening.

“Relying solely on China to support GDP growth revision is a bit heroic and presents strong downward risks,” he said. “Also, if you look at inflation in China, you will see that core inflation is going down quite sharply. Core inflation was 2% in 2018, before Covid, and now it’s about 1%. What does it mean? I do not see this as super good news. It reflects, clearly, a slowdown in economic activity - and not something recent.”

Europe’s “very clear” business cycle slowdown in 2022, with growth at a fourth-quarter standstill, was compounded by “worrying” negative investment, Ferrara said.

“The fact that we have zero is basically due to the external balance: we are importing less than we are exporting compared to the previous quarter. It's a huge difference, because in Q3 2022, we had the opposite, and investment was contributing positively to GDP growth for the whole of the euro area.”

HIT TO FRENCH GDP

France, meanwhile, could experience contraction in Q1 or Q2 this year, with political and social unrest in reaction to proposed pension system reforms causing annual GDP to drop by “a few percentage points.”

“Given the fact that we are slightly positive or close to zero, we could have thus negative growth. This is one of the risks that we are facing today,” Ferrara, who chairs the French Economic Association’s Business Cycle Dating Committee, said. “But if employment and investment continue on their current trend, we should avoid a recession."

March’s upward revision to 2023 eurozone core inflation means that not only will the ECB have to keep hiking to return inflation to the 2% target, but that it may have to overshoot, he argued. (See MNI EXCLUSIVE: ECB Should Hike As Market Fears Wane - Kazaks)

“The point that I would like to make - and I think it is going to be important, although few people have this in mind - is that if we were to plot a line for the expected price level assuming constant inflation at the target of 2% from 2001 to today, for the first time in the history of the ECB the observed price level for years to come will persistently be above this line," he said.

“It means that the observed price level and the one implied by the central bank’s price stability target will likely continue to evolve in parallel for a long period of time, with a gap of abnormally high prices, unless we have a period of deflation at some point; for example, a deflation of about -0.5% in 2024 will close the gap.”