Future of Europe After the British referendum Broader issues for the UK and the EU David Marsh, Managing Director, OMFIF 27 October 2016 Nicosia 1
European politics moves against integration A new phase of uncertainty after 23 June Hillary Clinton victory will lower one element of uncertainty Theresa May s honeymoon has ended after mixed messages on monetary policy Many different outcomes for Brexit process Initial EU solidarity after exit vote may not last Greece problems still simmering could emerge again before German elections Fundamental Franco-German differences - possible exacerbation in 2017 election year EU moving towards modest fiscal boost, in exchange for modest monetary tightening Teetering world growth, sluggish euro area - potentially explosive mix Europe once again the centre of global risks, debtors v. creditors struggle
Sterling fall reflects Brexit uncertainty Trade weighted sterling, Jan 1990 = 100, 1990-2016 120 115 110 Black Wednesday, ERM Crisis UK-EU referendum 105 100 95 90 85 German interest rate rise EMU start Lehman Brothers collapse 80 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: BoE Sterling s s trade-weighted level has shown great sensitivity to geopolitical shocks. While UK financial markets have largely rebounded after the June referendum, the pound has declined on doubts over operation of monetary policy. 3
Sterling depreciation and rising producer prices 15.0 Producer input prices YoY% growth rate, 2016 10.0 UK-EU referendum, Sterling depreciates 5.0 0.0-5.0-10.0 Source: ONS Jan Feb Mar Apr May Jun Jul Aug Sep Materials and Fuels purchased Import food prices Sterling s decline heralds higher UK inflation fulfilling the Bank of England target but raising the likelihood of further tension over falling living standards at a time of low wage growth 4
Eurosystem emerges as key source of risk 1000 Net Target-2 balances within the Eurosystem ( bn) 800 600 400 200 0-200 -400-600 2001 2003 2005 2007 2009 2011 2013 2015 Germany Spain France Greece Cyprus Ireland Italy Luxembourg Netherlands Portugal Source: Euro Crisis Monitor, Institute of Empirical Economic Research, Osnabrück University After a honeymoon that lasted until 2007, the euro area suffered severe buffeting, causing a marked increase in intra-euro Target-2 central bank balances, which have not normalised despite reduced tension since 2012 Italy s imbalance has started to rise again. 5
Euro crisis explained through the bond markets Euro area 10-year government bond yields, Jan 1993 to Sept 2016 35 30 Germany Greece France Italy Cyprus 25 20 15 10 5 0-5 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Eurostat The euro area lull until 2008 gave way to marked bond market pressure on the peripheral economies, threatening euro break -up until Mario Draghi s do whatever it takes speech in July 2012. The politics behind that speech has not yet been tested. 6
GDP per capita Index 2007=100 Large differences in Big Four members Real GDP per capita largest euro are member states, 2004-15 115 110 105 100 95 90 85 80 75 Source: IMF 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Germany France Italy Spain Greece s history of entanglement with economic and monetary union has been a long-running tragedy in many acts where there are many victims and few if any heroes. 7
GDP per capita Index 2007=100 Winners and losers of the euro crisis 105 Real GDP per capita Germany, Greece and the euro area, 2004-15 100 95 90 85 80 75 70 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: IMF Germany Euro area Greece Real GDP in Greece has declined by more than a quarter, a destruction of Great Depression proportions. 8
Real GDP Index 2007=100 Euro mismanagement has benefited Germany 115 Real GDP per capita Germany, Greece and euro area, 1999-2015 110 105 100 95 90 85 80 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: IMF US Germany Euro area excl. Germany Economic performance of the US and euro area developed in parallel during the first decade. Crisis mismanagement generated a sustained annual loss of about 10% of GDP per person, whilst Germany converged to the US benchmark level. 9
Percent of GDP Projected and actual paths of Greek government deficit and debt-to-gdp projections Percent of GDP 0 Deficit-to-GDP ratio, 1999-2015 180 Debt-to-GDP ratio, 1999-2015 170-2 160-4 150-6 140-8 130-10 120-12 110 100-14 90-16 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 80 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: IMF 2015 2010 2015 2010 Deficits were deeper, and the debt to GDP continued to widen. Greece s rescue plan from 2009-10 and the subsequent bail-out packages have offered a case study in how not to bring an economically ailing person back to health; although Greece has made creditable efforts to balance its books both internally and externally. 10
Real GDP, bn Percent Greece: 2010 projection and 2015 actual pathway 260 Real GDP, 1999-2015 Unemployment rate, 1999-2015 30 250 240 230 220 210 200 190 180 25 20 15 10 170 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 5 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: IMF 2015 2010 2015 2010 Greece s Real GDP did not return to pre-crisis level as projected but continued to decline. Unemployment jumped over 25%, rather than peaking at 15% assumed by the May 2010 programme. 11
Cyprus set to grow at 2% in 2017 Economic forecast, 2016 2014 2015 2016 2017 GDP growth, annual -2.5 1.6 1.7 2.0 Inflation rate, annual -0.3-1.5-0.7 1.0 Unemployment rate 16.1 15.1 13.4 12.4 Public budget balance (% of GDP) Gross public debt (% of GDP) CA balance (% of GDP) -8.9-1.0-0.4 0.0 108.2 108.9 108.9 105.4-4.6-3.5-4.2-4.6 Source: European Commission Growth has resumed in Cyprus and is expected to slowly gain strength with labour market conditions improving in parallel. The general government balance is expected to improve, supporting debt reduction. 12
Convergent outlook in OECD forecast 6 4 2 0-2 -4-6 -8 Real GDP growth, %, 2009-17 Inflation rate, %, 2009-17 6 5 4 3 2 1 0-1 -10 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: OECD France Germany Greece Italy UK -2 2009 2010 2011 2012 2013 2014 2015 2016 2017 France Germany Greece Italy UK Paradox of the referendum the UK is leaving the EU, in a bid to strike out on a new growth path - and yet its economic position is starting to converge with that of the rest of the EU 13
GDP per capita Index 2007=100 Divergence between euro area and the US 115 Real GDP per capita US vs euro area, 1997-20 110 105 100 95 90 85 80 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: IMF US Euro area (12) 14
Quantitative easing at leading central banks Pursuit of quantitative easing central bank assets, national currencies, 1 Jan 2008 = 100 470 420 370 320 270 Collapse of Lehman Brothers High point of euro crisis so far New wave of Fed QE Banks start repaying ECB liquidity 220 New wave of BoE QE 170 120 70 New wave of BoJ QE Fed announces tapering 20 2008 2009 2010 2011 2012 2013 2014 2015 2016 Bank of England ECB Bank of Japan Federal Reserve The industrialised world s four premier central banks have followed highly divergent approaches to QE since the outbreak of the financial crisis. The US and UK seemed to be converging but the new QE programme since August has changed the picture. 15
Germany gains ground in net foreign assets Net international investment position of world s three largest creditors 1997-2015, % of GDP 175% 125% Jan 1999 - euro introduced 75% 25% -25% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: IMF, World Economic Outlook database Japan Germany China Taiwan Norway Saudi Arabia 16
Spain, Italy and France among largest debtors Net international investment position of Spain, Italy, US, France and UK 1997-2015, % of GDP 20% 0% -20% -40% -60% -80% Jan 1999 - euro introduced -100% -120% 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 United States Spain Australia Italy Brazil France Source: IMF, World Economic Outlook database 17
How the stocks of world debt have changed Largest creditor economies NIIP ($bn) NIIP (% of GDP) 2015 2014 2015 2014 Japan +2,888 +3,041 +70.1 +66.2 Germany +1,620 +1,452 +48.3 +37.5 China +1,596 +1,776 +14.5 +17 Taiwan +957 +878 +180.5 +171.5 Norway +708 +708 +181.8 +141.5 Saudi Arabia +703 +792 +107.7 +105 Largest debtor economies NIIP ($bn) NIIP (% of GDP) 2015 2014 2015 2014 US -7,357-7,020-41 -40.5 Spain -1,065-1,208-88.8-87.3 Brazil -799-723 -26.6-50.1 Australia -689-553 -56.3-25.9 Italy -475-799 -26.2-33.1 France -416-508 -17.2-17.9 Source: IMF, OMFIF Analysis There have been important shifts in world debtor-creditor imbalances since 1999. Asia and Middle East remain large net creditors, but the biggest build-up of credits and liabilities has been in Europe. 18
Books since 1990, reports since 2010 19