A crucial start to the year for the euro area

The context of low inflation and uncertainty means that measures must be taken. The IMF predicts a scenario of a recovery at different speeds for the countries of the euro area, with the growth rate increasing from 0.8% in 2014 to 1.2% in 2015 and 1.4% in 2016. However, these forecasts are lower than its predictions three months earlier. In addition to this slow recovery is low inflation, unlikely to pick up even without the fall in oil prices. In this macroeconomic environment, the ECB has announced an important enlargement of the asset purchase programme it was carrying out in order to avoid the risk of deflation and promote growth.

The ECB will implement a quantitative easing programme of considerable size. The asset purchase programme has been extended to bonds issued by European governments, agencies and institutions. Asset purchases will total 60 billion euros a month and will take place from March 2015 to September 2016 (or until the inflation rate comes close to 2%). Total purchases will exceed 1.1 trillion euros and will be proportional to each country's share in the ECB's capital. The programme should reduce the risk premium of the periphery countries and cause the euro to depreciate, stimulating growth in the euro area. Business indicators for the euro area continue to register values in line with moderate activity although they started the year with a slight upswing. In January the composite PMI reached 52.2 points, its highest level for the last five months. Both the PMI index for services and manufacturing picked up. In Germany, the IFO (business climate index) and ZEW (index for investor and analyst expectations) improved for the third consecutive month. Demand indicators also looked more promising at the start of the year, in particular the consumer confidence index.

The drop in inflation expectations has pushed the ECB to act. In December, inflation stood at 0.2%, 0.5 pps less than the previous month, affected by the slump in oil prices. This negative figure for inflation in December is not the same as deflation (see the Dossier this month on inflation expectations) and it is important to stress that core inflation (without energy or unprocessed food) held steady at 0.7% for the third consecutive month. Nevertheless, risk of deflation is not neglegible as inflation expectations have continued to fall in the euro area. In such an environment, the start of the quantitative easing programme should boost inflation expectations. Just before Mario Draghi's announcement, these started to pick up again although we will have to wait to see whether the trend consolidates.

The quantitative easing programme will encourage the euro to depreciate further, boosting exports. The euro area's current account balance stood at 2.4% of GDP in November (cumulative over 12 months), maintaining the good tone shown during the year. One of the elements contributing the most to this progress is the increase in the goods surplus (due to the rise in exports) and, to a lesser extent, in services. Over the coming months, two factors will strengthen the current surplus. Firstly, the fall in oil prices will reduce the energy bill. Secondly, the mass purchase of assets will cause the euro to depreciate further. In fact, after the ECB announced its new measures, the exchange rate fell to 1.14 €/$ and we expect it to remain at this level over the next few months and then begin to depreciate again once the Fed starts to raise interest rates at the end of the year.

The improvement in activity will bolster the labour market's timid recovery in the euro area. In December the euro area's unemployment rate stood at 11.4%, 0.4 pps below its level one year ago. By country the decrease in unemployment in 2014 has been greater in the periphery and in the United Kingdom, while the labour market in France and Italy has deteriorated. At the start of this year the prospects for the labour market have improved: employment expectations in manufacturing and services have increased in all the countries of the euro area. Moreover, growth in activity in 2015, supported by lower oil prices, the ECB's programme and the euro's depreciation, will lead to improvements in the labour market.

Bank credit will support the recovery in 2015, boosted partly by the QE programme. January's bank lending survey shows that the criteria applied to approve loans in the euro area continued to ease in 2014 Q4, both for loans to non-financial firms and also for mortgages and consumer credit. This improvement was complemented with growing demand for credit in all categories in 2014 Q4. Moreover, the survey also shows that financial institutions expect demand to continue its recovery in the coming quarters. It is also interesting to note that disparities diminished between countries in granting credit to firms. Although the quantitative easing programme will have a greater impact on the exchange rate of the euro, it will also help to consolidate these existing trends in credit. The programme will increase the liquidity position of banks, making it easier for them to grant credit as well as improving conditions for companies and households.

Monetary policy must be complemented with structural reforms. The euro area's public deficit is gradually being corrected, falling from 7% in 2010 to 2.3% in 2014 Q3, so that a less restrictive fiscal policy can be implemented in 2015. In this respect the European Commission has temporarily lowered the deficit target by 0.5 pps for those countries carrying out far-reaching structural reforms (structural reform clause), a measure that could particularly benefit France and Italy. It has also confirmed that certain investments within the European Fund for Strategic Investments (the Juncker Plan) will not be taken into account when assessing whether a country has reached the public deficit target agreed with Brussels (although they will increase the country's level of debt). However, to achieve a sustained rate of growth in the euro area, countries must take advantage of the improved financial conditions of the ECB and of the Juncker Plan to carry out an ambitious agenda of structural reforms which substantially improve the growth capacity of their economies. This is particularly important in countries such as France and Italy which have a very limited potential growth rate.

Before the ECB's meeting, Switzerland's central bank took the surprising decision to no longer peg its currency to the euro, revealing the interdependence of monetary policies and their effects beyond the euro area's borders. The SNB's decision was mostly due to the difficulty in defending the Swiss franc against the European currency once quantitative expansion is underway. As a result, the Swiss franc appreciated considerably, directly affecting its economy, especially the banking sector and exports. The appreciation of the Swiss franc should not significantly affect emerging Europe even though these countries extensively make use of funding in foreign currencies. On the one hand, in the last few years they have reduced their financing in foreign currency and have undertaken measures to reduce their exposure. On the other, the region's high bank solvency should help them to absorb the effects of the depreciation of the main currencies in emerging Europe against the Swiss franc.

Syriza wins the elections in Greece, the first vote in a year containing important elections. This left-wing party fell just two seats short of an absolute majority and has formed a government in coalition with the nationalist right-wing party (ANEL). Both propose to carry out less fiscal adjustment and negotiate improved financing terms to pay back their debt. The first measures announced include raising the minimum wage to 751 euros, an increase in public hiring, free healthcare for anyone losing their job as well as other social measures for which they will need additional public funds. A long period of discussions has also started with the troika to renegotiate the debt, which look like being complicated (see the Focus «Greece: a new post-troika phase?»). 2015 will see several important elections in Europe, including the United Kingdom and Spain.