AXA IM: Restrictive change in government balance in all three larger economies in Euro area

AXA IM: Restrictive change in government balance in all three larger economies in Euro area

22 oktober 2024

Eurozone
Grafiek Koers.jpg

The change in the primary government balance – will be restrictive in all three larger economies of the Euro area next year and beyond, writes Gilles Moëc, AXA Group Chief Economist and Head of AXA IM Research, in his latest Macrocast. 

'We discussed last week how the French fiscal adjustment for 2025 would have some adverse effect on aggregate demand, but we now want to extend this to the Euro area as a whole' Moëc writes. He mentions that the information is still patchy but 'the massive step in Italy in 2024 reflects the end of the 'Superbonus', and the subsequent further tightening will – just like this year – be at least partly offset by the funds flowing from Brussels, but Germany, complying with its national 'debt brake' provisions, is planning a reduction in its structural deficit of 0.75% of GDP next year.'

Moëc adds: 'When averaging the national pledges, we find that the overall fiscal tightening would reach 0.9% of GDP in 2025, assuming of course governments stick to their plans. This would be the largest effort since 2012.' Moëc explains that initially, fiscal restriction since 2022 focused on phasing out extraordinary pandemic and war-related support, which had little impact on aggregate demand as private spending was rebounding. However, 'this is changing: the fiscal tightening will materialise while there is no 'catching up' left to do in private spending.'

Moëc goes on to write that getting the right level of the fiscal multiplier is key: 'What is at least consensus now is that multipliers are state-dependent: there is no absolute value, the impact of the fiscal tightening will depend on a range of contingent conditions, among which the monetary policy stance and broader financial conditions. With monetary policy moving away from restriction, the multiplier should be reasonable, somewhat below 1.'

However, there remains substantial uncertainty. 'Fiscal restriction today is necessary to avoid moving bond yields into restrictive territory,' Moëc explains, 'but it probably won’t reduce them much.' This means that much of the stabilizing work will fall to the ECB through monetary policy.

'This is another reason why the ECB, even if it starts sending clearer messages on the overall trajectory past December, will have to remain data dependent in the sense that it will have to stand ready – beyond the external shocks – to take on board a powerful reaction to the fiscal tightening in 2025, which may force to descend into properly accommodative territory (i.e. below 2%). Of course, luck can be on the ECB’s side and the reaction of the economy to its monetary loosening can come out at the upper end of its models’ range, but precisely: such reaction has a higher probability to materialise if the ECB is more forceful on its messaging, by lifting confidence,' Moëc concludes.

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