Euro Area Recovering, But Lasting Growth Requires Collective Push

Euro area recovering but stronger growth needed to boost jobs

More balanced policy mix can generate large growth dividends

Cleaning up bad bank loans can help support more lending and investment

Although unemployment is still high, steady job growth and rising real wages have underpinned a rebound in consumption, the report said. Strong policy actions by the European Central Bank (ECB) have also boosted confidence and improved financial conditions.

Among the large economies, Germany continues to grow slightly above 1½ percent, while Spain is rebounding strongly. Italy is emerging from three years of recession, and activity in France picked up at the beginning of this year.

The recovery is supported by cheaper oil, monetary easing, and a weaker euro, with growth in euro area economies expected to rise modestly to 1.5 percent this year and 1.7 percent in 2016.

But medium-term prospects are less bright. “Several factors cloud the outlook for growth over the next five years,” said Mahmood Pradhan, mission chief for the euro area. “These include high unemployment, especially among the youth; large corporate debt; and, rising non-performing loans (NPLs) in the banking system.” Slow progress on structural reforms has also dampened the business climate and reduced growth potential. As a result, the euro area remains vulnerable to shocks. “A moderate shock to confidence—whether from lower expected future growth or heightened geopolitical tensions—could tip the block into prolonged stagnation,” said Pradhan.

To counter the risks of stagnation, the report called for a stronger collective push to strengthen the recovery and make the monetary union more resilient.

Strengthening demand

Staying the course on the expanded asset purchase program, or quantitative easing (QE) is essential, says the report. “While quantitative easing has already improved financial conditions and raised inflation expectations, international experience suggests that its impact on the real economy will take more time,” said Pradhan. But strengthening bank and corporate balance sheets could significantly amplify the impact of quantitative easing via more bank lending to revive credit growth. While there are currently few signs of scarcity in sovereign bond markets, the ECB should develop a common securities lending framework to increase the availability of collateral for market participants. Macro-prudential policies should serve as the first line of defense against potential...