01 July 2013

EY Eurozone Forecast: Summer 2013 - Outlook for financial services

With the eurozone economy expected to contract this year and unemployment forecast to reach a 12.7 per cent peak in 2014, there are clear challenges ahead for financial services. While NPLs were expected to peak this year, the ECB's AQR could push the peak out to 2015 in some markets.

• Lending to hit new lows in 2013 as total banking assets fall back to 2008 levels
• Write-offs will peak at 7.5 per cent in 2013 and will still sit at 4.3 per cent by 2017
• AQR may force banks to shrink balance sheets by further €1.5 trillion
• Household wealth up 23 per cent by 2017 creating opportunities for investment products
• GDP in 2013 will fall 0.6 per cent, a slightly larger decline than in 2012. The recovery should begin in 2014, with GDP growing just under 1 per cent.
• The unemployment will peak at around 20.5 million in early 2014, equal to 12.7 per cent of the workforce.
• The ECB cut interest rates in May and is likely to implement measures to encourage loans to small and medium-sized enterprises (SMEs).
• Some peripheral countries have already made significant progress as extreme financing constraints have forced much-needed reforms such as labour market regulation and social welfare systems.
• Eurozone outlook for financial services – The environment remains challenging for financial services but there are opportunities available for companies able to seize them.

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Two contrasting sets of forces are at work  behind this forecast: on the upside, the focus of fiscal policy is  at last shifting from short-term austerity to  longer-term credibility. There is increasing acceptance among policy-makers that the pace of austerity should be slowed. Some countries have been given more time to reduce their budget deficits to 3 per cent of GDP. EY estimates that halving planned austerity measures would raise eurozone GDP by 1 per cent by the end of next year, with Greece and Spain benefiting most. On the downside, the outlook for emerging markets is cooling as the world adjusts to slower growth in China. This will limit the scope for eurozone economies to expand through exports. Recent developments in global exchange rates will also make it harder for eurozone companies to compete, as many emerging market currencies have been slipping against the euro. A sharp fall in the yen is hampering export prospects  by intensifying competition from Japan.

For these reasons, EY expects a slower bounce-back than previously envisaged.Slow recovery increases unemployment. A consequence of the delayed recovery has been high – and still rising – rates of unemployment. EY now forecasts unemployment to peak at 12.7 per cent early next year, rather than 12.2 per cent. This means EY is expecting an additional one million unemployed workers. As a result, private consumption will contract again this year, bringing further challenges for businesses. It also delays the reduction of private sector debt, which needs to fall before the economy can sustain robust growth. With so many people out of work, rising rates of youth and long-term unemployment bring particular concerns. Almost half of those unemployed have been without a job for more than a year. These workers become deskilled and detached from the labor market, hindering the eurozone’s medium-term growth prospects. There is also a risk of social unrest, as governments will face stiff protests against fiscal consolidation and other reforms that would cost jobs in the short term.

Slow recovery  lowers interest rates. A quarter-point cut in the European  Central Bank (ECB) refinancing rate in May reflected these poorer growth prospects. But cutting interest rates when they are already so low will do little to stimulate the economy. Neither will it address the wide disparity in corporate borrowing rates across the eurozone, which is so damaging for peripheral economies. The ECB has side-stepped this issue so far, but it has instead begun to encourage much-needed structural reforms.

With the shift in focus toward longer-term fiscal credibility, there is now more scope to improve competitiveness. Some of the countries hardest hit have already been forced to reform labor market regulation and social welfare systems. There are signs that the Eurozone will emerge stronger from the crisis.

Banking sector highlights

• Banking service demand still weak, profit margins continue to be squeezed and balance sheet consolidation continues through 2013.
• Assets set to fall back to 2008 levels this year, but 2013 should mark the bottom of the cycle.
• NPLs expected to reach 7.5 per cent of total loans in 2013, a higher peak than previously thought.
• Total loans forecast to grow by 17 per cent between 2013- 2017.
• ECB’s AQR could force faster restructuring: banks may need to shrink balance sheets by a further €1.5t.

Insurance sector highlights

• Life premium growth expected to rise by only 1.3 per cent in 2013, but should pick up pace to 2.6 per cent between 2014 and 2017.
• Low interest rates have raised the cost of providing term products, making it hard for life insurers to balance investment risks and returns, and reducing profits.
• Car sales and house prices set to pick up and corporate profits are forecast to rise from 2014, pushing non-life premiums to an average 2.6 per cent between 2014 and 2017.
• Profits for eurozone insurers increased by 11 per cent in 2012, helped by cost-cutting measures.
• By 2017, gross household wealth expected to rise by 23 per cent, bringing new business opportunities.

Asset management sector highlights

• AUM growth expected to slow from 12 per cent in 2012 to 8 per cent this year, before averaging 4 per cent between 2014 and 2017.
• As confidence returns, investors are expected to move out of German and French bond markets in search of higher yields with increased focus on the

US and emerging markets

• Current low household income (especially in the periphery) is expected to encourage some investors to cash in positions.
• Low volatility of bond yields in the periphery expected to increase their attractiveness.
• The strong hedge fund performance in 2012 continues, earning 5.7 per cent so far this year.

Press release

Full forecast

See also Asset Quality Review will extend Eurozone’s banking pain beyond 2013

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