Europe is looking up – some good news to start 2016

The EU is poised for strong growth this year Photo: AFP/GETTY IMAGES

Now we have moved into a new year, economists are peering into their crystal balls and making predictions for the next 12 months.

One of my forecasts would be for stronger European economic growth. Indeed, this could well be the strongest year for growth across the European Union as a whole since 2007.

This may be a surprising prediction. We have become used to viewing Europe as a drag on the growth of the UK and world economies. After a spurt of growth in 2010, the economies of the eurozone stagnated from late 2011 until mid-2014. But 2015 saw much a better economic performance.

The Baltic states, Latvia, Lithuania and Estonia, have enjoyed fairly consistent economic growth  Photo: Alamy

Taking the 28 economies of the EU together, GDP in the third quarter of 2015 was 1.9pc up on a year ago, only just behind the 2.1pc growth achieved in the US over the same period. The EU unemployment rate has now fallen to 9.3pc - the lowest level for more than six years.

Where is this growth coming from? During the recovery from the financial crisis there have been two consistent sources of strength and resilience in the European economy. The first is northern Europe, led by Germany and the UK. Sweden is another northern European economy that has performed well, and is now growing at nearly 4pc a year.

A second area of fairly consistent economic strength has been eastern Europe – including Poland, the Czech Republic, Slovakia and the Baltic states – Latvia, Lithuania and Estonia. The 11 central and eastern European economies that joined the EU from 2004 onwards make up an economy the size of Spain. In recent years, they have exerted a positive counterweight to the drag created by the trou bled economies in southern Europe.

Since 2014, however, the performance of some of the southern European economies has started to improve.

Spain has seen the biggest turnaround – with growth picking up to 3.4pc and unemployment falling by 500,000 over the past year. There has been a more modest improvement in Portugal. Italy has also seen a big fall in unemployment, and business surveys there are becoming more positive – though this is taking time to feed through into stronger GDP growth. Greece is still struggling – but it has a small impact on the overall European economy, accounting for just over 1pc of EU GDP.

Spain has seen the biggest turnaround Europe  Photo: Alamy

Why have we seen this improvement in southern Europe – particularly in Spain? One important ingredient has been the reforms implemented by the Spanish government to employment laws and other regulations affecting business – under the government of Prime Minister Mariano Rajoy.

However, the inconclusive result of the recent Spanish election has raised question marks about the future of this reform programme.

In Italy, the government, headed by Mario Renzi, is embarking on a similar process of reform – though it will be some years before its full impact on the economy will be felt.

In addition, the European economy as a whole has felt the impact of three other favourable effects over the past 12-18 months.

The first is the big fall in the oil price, which has helped to bring down inflation to around zero. The continental European economies are large beneficiaries of this shift as none of them is a large oil producer. Zero inflation means that real incomes are rising, with wage-earners seeing modest pay increases. For example, German workers saw a 2.5 pc increase in the real purchasing power of their wages last year.

Meanwhile, the fear of a damaging deflationary cycle is misplaced. In countries, like Spain, where prices are falling, it is boosting, not damaging, economic growth.

A second positive feature is the European Central Bank's quantitative easing (QE) programme, which has supported confidence in financial markets and the economy more generally. On its own, QE is not a magic bullet to restore growth. But as we saw in the UK and the US in 2009, it can turn round financial sentiment and boost confidence when other factors are becoming more positive.

The fear of a damaging deflationary cycle is misplaced. In countries, like Spain, where prices are falling, it is boosting, not damaging, economic growth
Source: Europe is looking up – some good news to start 2016