Cheap oil keeps eurozone economy breathing

Commission estimates that eurozone economy in 2015 could grow by 4% or contract by almost 1% with the effects of low oil prices and devalued euro on economy being hard to predict

On the face of it, the European Commission’s latest economic forecasts hold out a glimmer of hope, upgrading its forecasts for the eurozone economy in 2015. Yet dig deeper and that same upgrade appears ever so underwhelming.

The Commission highlighted factors that would push growth up to an estimated 1.3% in 2015 and 1.9% in 2016.

The collapse in energy prices over the last six months or so, as the price of a barrel of oil on global markets has halved, will hand consumers a sizeable ‘tax break’ while bumping up corporate profits.

The European Central Bank will pump some €500 billion into the eurozone economy in 2015 after announcing a programme of quantitative easing in January. That money will flow to banks which should reinvest it into the real economy. In parallel, the value of the euro is falling. It has lost a sixth of its value against the dollar in one year. That will improve the competiveness of eurozone business and boost exports.

Yet the picture is far from rosy. Pierre Moscovici, the European commissioner for economic and financial affairs, said that these factors were equivalent to a “shot in the arm” for the European economy. But a life-support machine may have been a more appropriate image. Consider that the eurozone will barely outpace the 2015 predictions made last autumn and will underperform the 2014 winter forecasts, which predicted a hopeful 1.8% of growth in 2015. Spare a thought for the state the eurozone economy would be in without all this help.

Oil economics

The Commission assumes that the price of oil will average out at $53 per barrel in 2015 and $61.5 per barrel in 2016 (see graph, below). If that proves correct, the collapse in the oil price from $100 per barrel in July is having seismic effects on the global economy.

“Falling oil and commodity prices are redistributing income from commodity-exporting countries to commodity-importing ones on a massive scale,” observes the Commission in the report.
Europe is a commodity-importer and ought to gain significantly,  with some countries doing better than others.

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Germany, with its energy intensive industries and weak consumer demand, is foremost among them.

In Latvia, fuel costs represent 6% of all household spending, meaning that consumers will feel the benefits of lower prices. A similar situation exists in Poland where consumer spending is expected to maintain gross domestic product above the 3% mark.

Yet of all the countries surveyed by the Commission, it is the United States that will gain the most from cheap oil. That is in part because of the strength of the dollar against the euro: the devaluation of the euro makes oil more expensive. But it is also influenced by the US economy. “Lower oil prices [will] provide a major boost to private consumption, which accounts for roughly 70% of US GDP,” says the Commission, upgrading its forecast for US growth in 2015 by 20 basis points to 2.4%.

The collapse in oil prices is not all positive news for European countries. The governments of Denmark and the United Kingdom will see tax revenues fall as profits from national extraction industries dry up. But the real pain is being felt in Norway and Russia. The oil and gas industries make up about one-fifth of Norway’s gross domestic product. The collapse in prices has cut growth expectations there for 2015 by 1 percentage point.

The effect on Russia, where energy exports contribute about half of the government budget, is even more dramatic.

Collapsing oil prices have prompted a 25% fall in the value of the Norwegian krone and halved the value of the Russian rouble, both compared with the US dollar.

Yet in the eurozone, the devaluation of the euro is seen as positive in most quarters, with exporting nations such as Italy, Spain and to some extent France standing to gain from a weaker euro.
The picture is more mixed for an exporter like Germany, whose firms tend to have more globalised production processes. A weaker euro could make a car that contains many imported parts more expensive, for example.

The Commission assumes that the euro will hover at an exchange rate of $1.17 dollars in 2015 and 2016. That may be conservative. Barclays, a British bank, predicts that the euro will reach parity with the dollar by the end of this year. Similarly, Citigroup, a US bank, has predicted that the price of a barrel of oil could tumble to as low as $20.

The Commission is well aware of the fragility of its predictions. It concedes that in 2015 the economy could grow by as much as 4% or contract by almost 1% (see above). Which suggests that no one, let alone the Commission, knows what 2015 has in store for the eurozone.