Dark clouds hanging over eurozone

American steel and aluminum tariffs and populist political surges could spoil recent growth in the eurozone, and the latter could even threaten the future of the euro currency. PHOTO: European Union 2017 – European Parliament

LONDON—For months, the 19-country eurozone has been one of the bright spots in the global economy, with growth and job creation picking up steam after years of crisis management and a lack of confidence.

But on Monday, the outlook appeared murkier after the rise of populist parties in Italy’s general election Sunday and mounting fears of a global trade war after President Donald Trump backed tariffs on aluminum and steel and warned that more could come, even on European cars.

That murkier outlook has come at a time when the eurozone economy appears to have peaked at a historically high level. Financial information firm IHS Markit said Monday that the eurozone slowed in February possibly due to heightened political uncertainty in Germany and Italy.

The firm’s so-called purchasing managers index, a gauge of business activity, slipped to 57.1 points from January’s 12-year high of 58.8. Chris Williamson, the firm’s chief business economist, said it’s “too early to read too much” into the monthly decline but noted that some pull-back was “always on the cards.”

Though the political uncertainty surrounding Germany has been lifted somewhat by Sunday’s decision by the centre-left Social Democrats to remain in a coalition with Chancellor Angela Merkel’s conservative bloc, the situation in Italy is far from clear.

Preliminary results released by Italy’s interior ministry showed the centre-right coalition winning about 37 per cent of the parliamentary vote and the 5-Star Movement getting about 32 per cent, with the centre-left coalition far behind with 23 per cent.

However, no party or alliance of like-minded parties gained enough support to govern alone, an outcome that will herald a period of fraught coalition discussions.

Analysts said it’s too early to gauge the impact on the Italian economy, which has been improving over the past year. In 2017, it expanded by 1.5 per cent. Though that’s a full percentage point lower than the eurozone’s overall growth, it was Italy’s best performance since 2010.

“The prospect of a prolonged period of domestic political uncertainty risks weighing on the ongoing recovery,” said Nicola Nobile, an economist at Oxford Economics. “For now, we are not making any changes to our forecast but we will revisit it once the dust has settled.”

That appears to be reflected in the markets. Italy’s main stock market was down 1.2 per cent on a day when other European markets were higher. The euro currency was barely changed.

The longer-term worry for investors is that the Italian election may stoke renewed concern about populist forces in the eurozone, nearly a year after many of those were vanquished by the outcome of elections in the Netherlands and France, in particular. This time last year, the rise of populism was considered by many economists as the gravest cloud hanging over Europe’s economic future, especially as worries over Greece had abated. The great fear for those overseeing the euro currency is that a party may come into government seeking to get out of the single currency and revert to the country’s original currency.

Externally, the eurozone economy faces another potential headwind from Trump, who said he planned to levy penalties of 25 per cent on imported steel and 10 per cent on aluminum imports from next week. Leading EU officials have warned of retaliation, which prompted Trump to warn he could go further and slap tariffs on European cars.

“This obviously raises the threat of a downwards spiral of tit-for-tat tariff barriers being imposed by the EU and the U.S., leading us to a genuine trade war, with spillover effects onto most other economies,” said Michael Every, a strategist at Rabobank International.