Growth in the Euro Area Has Never Been So United
Monetary policy divergence remains a prominent theme heading into 2016, with most market participants expecting central banks in the U.S. and the euro area to take their policy rates in different directions next month for the first time since 1994.
For members of the common currency area, however, the past few years have been marked by a period in which economic performance has converged substantially.
In fact, growth in the currency union has never been so united, notes Bank of America Merrill Lynch.
Chief European Economist Gilles Moec and Economist Ruben Segura-Cayuela observe that the standard deviation of GDP growth among the 19 countries that use the euro has been trending downward since 2011:
"Indeed, 2015 has been the year when the dispersion of economic performance across member states has been at its lowest since the creation of the euro area, [and] we expect two more years of further compression," write Moec and Segura-Cayuela. "We expect the main sources of growth during 2016–improvement in lending flows, the lagged impact of the oil price drop, reversal of austerity, gradual weakening of the currency–to benefit most the laggards in the recovery, while the weaker external outlook will not help those, such as Germany, that have outperformed in recent years."
This theme of European convergence will also extend to inflation rates, the pair suggests.
Like Barclays, Bank of America sees growth in the euro area as fueled primarily through domestic demand in 2016.
However, this convergence in growth appears to be more a fluke than a calculated goal, the economists conclude, seeing the persistence of an "unstable equilibrium" based on "uneasy compromise between supply-siders and Keynesians in policymaking," in which disagreements have arisen over whether austerity and reforms or fiscal stimulus is the best course of action.
The economists dub this state of affairs the "European Catch-22" and opine that "the latest episodes of the Greek crisis and the current refugee crisis are examples of how Europe has reached the limits of further integration."
The accommodation provided by the European Central Bank has preserved this fragile equilibrium, according to Bank of America, and thus should end once quantitative easing in the currency union is over.
But for the near term, Wall Street is warming to the notion of less variance in economic performance in the euro area, which will also be reflected in financial metrics.
Strategists at Goldman Sachs also highlighted a European convergence trade as one of its top ideas for 2016, calling for the spread between the five-year, five-year forward Italian sovereign yields and their German counterparts to narrow to 100 basis points. It's now roughly 150 basis points.