Archive: Deflation, low growth and political uncertainty: trouble in the EU

Published 4 February 15

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With the Eurozone once more on the brink of recession and growing fears that Greece could leave the single market, the Euro fell against all major currencies. By the 27th January, the single currency was at a seven-year low against the Pound at €1=£0.75 and an 11-year low against the Dollar at €1=$1.13.

For UK businesses, this means that exports will be less competitively priced, while imports from the EU will be relatively cheaper. However, with the Euro falling across the board, it is unlikely that the UK will be inundated with imports from the Single Market. Exports from the area will be more competitively priced in a number of markets, particularly for products priced in Dollars (such as wheat and milk powders) which are traded globally.

There is, however, a further risk from the weakening European economy of falling demand, particularly for higher quality, higher-priced products as household income and consumer confidence are both impacted.

Downward pressure on the Euro 

With GDP for the third quarter expanding by a marginal 0.2%, the Eurozone managed to keep clear of recession, though the economy remains fragile. Unemployment is only very slowly coming down and even in key economies such as Germany, business confidence remains low. Moreover, inflation just turned negative, tipped over by falling oil prices, prompting further moves by the European Central Bank (ECB) to try and stimulate growth.

The ECB’s decision to try and stimulate growth through quantitative easing, coupled with the decision from the Swiss National Bank to break the link between the Franc and the Euro, resulted in sharp falls in the value of the Euro against all major currencies. However, the most recent factor putting downward pressure on the single currency has been the general election in Greece. Even before the results came out, the prospect of a win from a left-wing party campaigning on renegotiating Greece’s debt commitments, brought fear to financial markets, politicians and policymakers alike. It seems likely that the Euro will remain volatile in the short term as the risk of the ‘Grexit’ remains a possibility.

Better prospects in the UK

In contrast with the EU, the UK economy has continued to strengthen, with growth hitting 2.6% for 2014, it’s fastest pace since 2007. There are, of course, still weaknesses in the economy and inflation figures, at just 0.5%, are low. Like deflation, low inflation is typically associated with raising the burden of private debt as incomes grow more slowly than loan repayments. However, the latest inflation figures have been primarily driven by the fall in oil prices.

Oil prices have more than halved over the last six months and have been a significant driver in allowing nominal wages to overtake inflation rates. Until late last year, real wages had been consistently dropping since 2010, the longest period of falls since at least 1964. In other words, wages had not kept pace with the rising cost of goods and services. It was only towards the end of last year that growth in real wages finally turned positive again. Falling oil prices have increased disposable incomes for households, contributing to increased consumer spending and confidence. Hopefully, this will turn into better prospects for UK agricultural producers targeting domestic consumers.