Few investors are still unaware of the huge medium-term challenges facing the euro area—particularly the risk that it might be trapped in a period of very low nominal growth. But it’s important to realize that, this year at least, the economy is likely to benefit from powerful cyclical tailwinds.

The most obvious of these are the oil price and the exchange rate. In euro terms, the oil price is currently about 35% below its average level in the first half of last year, while the euro’s trade-weighted exchangerate index has fallen by almost 10% over the same period. Using standard rules of thumb, these two changes should add roughly 1% to economic growth in the coming year.

Real Income Boost

So far, the most visible impact of the lower oil price has been on headline inflation, which slipped to -0.6% in January. Not surprisingly, this has added to concerns that the region is slowly succumbing to deflation. But it’s important to remember that the drop in the oil price will have a positive impact on real income growth in the euro area—similar, in essence, to the fiscal impulse that would be provided by a reduction in value-added tax rates.

In the third quarter of 2014, the last period for which data are available, annual growth in nominal wage and salary income in the euro area rose to 2.3%. If, as seems likely, a similar growth rate is recorded in the first quarter of the current year, annual growth in real labor income should rise towards 3.0%. This would be close to the cyclical peaks seen in 2001 and 2006/07 (Display 1), when consumer-spending growth was considerably stronger than it is at present.

Much will depend on the extent to which consumers decide to spend or save the windfall gain from oil. It’s not certain which way they’ll swing. However, we’re encouraged by the recent pickup in consumer confidence, particularly indications that households may be more willing to make major purchases than they have been at any time since 2006 (Display 2). The theory that falling prices will encourage consumers to postpone purchases remains unproven, in our view: there’s certainly little evidence of it in the euro area at present.

Supportive Policy Mix

Importantly, these positive developments are occurring at a time when the policy mix in the euro area has become more supportive of growth. After a period of damaging austerity between 2010 and 2013, our estimates suggest that the overall fiscal stance for the region is likely to be neutral/mildly expansionary this year. Hardly the aggressive stimulus many observers would like to see, but an important step in the right direction (at least so far as economic growth is concerned).

Improved Money and Credit Dynamics

One of the euro area’s biggest problems in recent years has been the fragmentation of the single monetary policy. Among other things, this has led to companies in the periphery being charged considerably more to borrow money than those in core countries.

However, as Display 3 highlights, bank lending rates for Italian and Spanish companies have fallen sharply in recent months. Although rates are still higher than in Germany or France, this indicates that the single monetary policy is becoming less fragmented and that the monetarytransmission mechanism is starting to recover.

This is also the message from recent bank lending data. In the final quarter of 2014, net new loans to euro-area households and firms rose by €19 billion. Not only was this the best quarter since the beginning of the credit crunch in 2011 (Display 4), but the mix was also encouraging, with loans to nonfinancial companies finally starting to pick up (note that mortgage borrowing continued to grow throughout the crisis).

Recent monetary developments also point to brighter times ahead. The narrow money aggregate M1* has long been regarded as a possible leading indicator for euro-area growth. In December, real M1 growth was running at 8.0%, the fastest growth rate since May 2010. Moreover, with inflation falling steeply in January, it’s likely to rise even further in the new year. If M1 is any guide, a significant acceleration in output growth looks possible in the coming year (Display 5).

Cyclical Outlook

Brightens In recent years, much has been written about the bleak medium-term outlook for euro-area growth. We agree with a lot of this. But that doesn’t mean the business cycle is dead. In our view, the conditions for a cyclical pickup in euro-area growth are better today than they have been at any time since the onset of the global financial crisis. Against this backdrop, consensus forecasts for euro-area growth are probably too low and look set to move higher (we expect 1.5% growth this year compared with the current consensus estimate of 1.1%).

Of course, there are important caveats to consider. One relates to a possible breakdown in the bailout negotiations between Greece and its euro-area partners. However, so long as this doesn’t result in a default and/or euroarea exit, we doubt this will have a material impact on growth elsewhere in the region.

Another is that faster real growth is likely to come largely at the expense of lower prices. This means that nominal growth— the key for debt sustainability—is likely to be little changed this year at 1.8% after 1.6% in 2014. Still, this is likely to keep the European Central Bank firmly in accommodative mode—even if, as we expect, growth surprises on the upside.

By Darren Williams, Senior European Economist—Global Economic Research and Dennis Shen, Economic Associate—Global Economic Research,, AllianceBernstein

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The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. This document has been issued by AllianceBernstein Australia Limited (ABN 53 095 022 718 and AFSL 230698). Information in this document is only intended for persons that qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia), and should not be construed as advice.

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Balance-of-payments data show that euro-area residents purchased €36 billion of foreign bonds in November. This continues a trend that started in the first half of last year and gained pace after the European Central Bank (ECB) cut its deposit rate into negative territory in June. Between June and November 2014, euro-area residents bought €200 billion of foreign bonds (Display 1). This compares with €33 billion in the same period a year earlier and is the strongest outflow since the financial crisis struck.

The chief beneficiaries of these outflows have been the US and the UK. According to quarterly data from the ECB, euroarea residents bought €77.8 billion and €37.0 billion respectively of US and UK debt securities in the second and third quarters of 2014. These two countries accounted for roughly two-thirds of all foreign-bond purchases during this period (Display 2).

QE Accelerant

Looking ahead, there is every reason to expect euro-area residents to continue buying large quantities of foreign bonds. Last week, the ECB announced that from March this year until September 2016, it intends to buy €60 billion per month of public and private sector debt securities. Moreover, it plans to do this at a time when interest rates in the euro area are already at incredibly low levels—not only is the ECB’s deposit rate negative, but so too are short-dated bond yields in core Europe.

Against this backdrop, there is little doubt that much of the liquidity injected by the ECB will flow into overseas markets. And while the US and UK might be the first ports of call, other higher-yielding markets are also likely to benefit. Quantitative easing (QE) in the euro area is therefore likely to exert considerable downward pressure on global bond yields.

Bond Flows Swamp Current Account

Bond outflows from the euro area are also likely to have implications for exchange rates. For all the region’s difficulties, the euro had, until recently, remained strong. One of the main reasons for this was a large and rising current account surplus— in much the same way that Japan’s huge current account surplus supported the yen during the 1990s.

While its strong current account position continues to represent an important source of structural support for the euro, the overall balance of payments looks much less favorable. Between June and November 2014, the euro area’s current account surplus was €147 billion, or 2.4% of gross domestic product in seasonally adjusted terms. At the same time, the region also benefited from a net equity inflow of €113 billion. However, all other components of the balance of payments showed net outflows during this period.

As Display 3 shows, between June and November last year, net direct investment in the euro area was minus €43 billion and net banking flows were also negative (to the tune of €61 billion). But the biggest outflow was via the bond channel. With euro-area residents gobbling up €200 billion of foreign bonds and overseas residents off-loading €42 billion of euro-area bonds (the strongest sales by foreigners since the height of the sovereign-debt crisis), net bond outflows from the euro area reached €242 billion between June and November last year.

In our view, the current account is likely to be a positive factor for the euro for some time to come. Moreover, an improving cyclical backdrop and weaker currency could continue to attract equity—and, in time, direct investment—inflows into the region. But with short-term interest rates negative and the ECB about to embark upon a large-scale asset-purchase program, the euro is likely to face a formidable headwind in the form of continued large bond outflows.

By Darren Williams, Senior European Economist—Global Economic Research and Dennis Shen, Economic Associate—Global Economic Research, AllianceBernstein

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The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. Note to Canadian Readers: AllianceBernstein provides its investment management services in Canada through its affiliates Sanford C. Bernstein & Co., LLC and AllianceBernstein Canada, Inc. This document has been issued by AllianceBernstein Australia Limited (ABN 53 095 022 718 and AFSL 230698). Information in this document is only intended for persons that qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia), and should not be construed as advice.

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