US and eurozone growth rates seem to converge

At the beginning of 2015, the US was thought to have embarked on a vigorous upswing, with economic growth of at least 3 per cent in prospect. The Federal Reserve was (and still is) talking of imminent monetary tightening. Meanwhile, the eurozone was believed to be stuck in the economic doldrums and the European Central Bank was just about to announce a programme of quantitative easing. Yet now the growth momentum of the US is slowing, while that of the eurozone is improving.

So what is happening and why? And what might it imply for policies?

So far, the consensus of forecasts has not shifted appreciably. The March consensus was still for US growth of 3.1 per cent in 2015 and 2.9 per cent in 2016. Meanwhile, the eurozone is forecast to achieve only 1.4 per cent growth year and 1.7 per cent in 2016.

Yet, as Gavyn Davies notes, a big shift in relative performance is under way. He estimates that the annualised rate of US growth is now running at only 2.0 per cent, down from 2.5 per cent a month ago, and 4.0 per cent last autumn. Meanwhile, annualised growth in the eurozone is 1.7 per cent, up from 1.3 per cent in February.

As a result, the gap between US and eurozone growth rates has narrowed to only 0.3 percentage points, compared to one of 3.5 percentage points last summer. If this persists, the consensus forecast will prove wide of the mark.

It is hard to know precisely why this is happening. But, among the explanations must be the collapse in oil prices, the depreciation of the euro and the belated recovery of crisis-hit eurozone economies, notably Spain and Italy.

The eurozone contains no significant oil producer. As a result, the collapse in oil prices is an unambiguous boon to its economy. In the US, however, the balance is more even, given the size and dramatic recent growth in production of - and investment in - oil.

Again, the most powerful effect of the ECB's newly aggressive monetary policies has been on the exchange rate: according to JPMorgan, the eurozone's trade-weighted real effective exchange rate depreciated by 14 per cent between December 2013 and March 2015. This will bring large gains to its internationally exposed businesses.

Finally, the eurozone economy as a whole is still smaller than it was in the first quarter of 2008, while unemployment is over 11 per cent of the labour force, against 5.5 per cent in the US. The economy was long due some sort of rebound. This could at last be it.

Yet it is far too soon to conclude that it is enjoying a strong and sustainable upswing: even if it were to achieve 2 per cent growth this year, the economy would only have recovered ground lost since the financial crisis. Cyclical unemployment would remain far too high and inflation still threateningly low: eurozone core inflation was just 0.6 per cent over the most recent period of 12 months. There is no reason to change monetary policy.

More significant and, above all, far more unwelcome is the apparent slowdown in the US. This underlines the need for extreme caution by the Fed in tightening monetary policy. The US economy is still operating against powerful headwinds, both the longstanding ones of excessive debt and weak investment and the more recent one of a soaring dollar. The case for tightening monetary policy soon is weak, if not non-existent. This is particularly true if the Fed is likely to regard its first hike as the precursor of many more.

The Fed should bide its time. As we have learnt again and again, the underlying economic dynamic is very weak. "Secular stagnation" may be an exaggeration. Alas, it is not a big one.

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