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The narrow window that could have allowed the European Central Bank to lift its key interest rate from negative levels has closed. The case for an increase on inflation grounds was already weak; now rapidly slowing growth, falling inflation and jittery markets weaken the case still further.

The global monetary cycle has also shifted. We expect just one quarter-point rate rise from the US Federal Reserve in 2019, then cuts by late 2020, and we see ECB rates on hold until at least the end of next year.

A bigger question is whether the window for continued economic expansion has also closed. Dismal European economic data, those jittery markets, and slowing trade suggest growth hasn’t bottomed yet.

Germany and Italy should narrowly avoid full-blown recession but the risk has risen and French consumers need to shrug off the ‘gilets jaunes’ protests quickly. Spain is the only major economy bucking the trend, with improving employment and an investment recovery buoying domestic demand.

However, there are several reasons for cautious optimism. A year ago, when rising inflation was a bigger risk, markets wrongly priced in more tightening. Could they be making a similar mistake now? Some of the eurozone weakness reflects one-off factors, meaning underlying growth may not be falling as fast as the figures suggest. And the global economy is slowing, not collapsing: US consumer confidence and payroll growth remain robust and China has scope for further stimulus and infrastructure investment.

Eurozone growth should also be boosted by looser fiscal policy: we forecast the primary fiscal deficit to widen by 0.5 per cent of GDP in 2019. And an improving labour market and rising pay growth should underpin consumer spending. We therefore forecast eurozone growth of 1.4 per cent in 2019 and 1.3 per cent next year – even though the ECB expects 1.7 per cent in both years. The long term is of greater concern. The window for using the eurozone upswing to make structural reforms or rebalance the economy has closed too. The threat from populist politicians leaves leaders little appetite for reforms that take time to bear fruit.

The European Parliament, Council, Commission and ECB will all have new presidents this year and the leadership of four of Europe’s five largest economies – Spain, Italy, the UK and even Germany – could change too. That’s a lot of political change at a crucial time, especially when Britain’s EU exit is so uncertain.

Brexit dominates the UK outlook and negotiating a long-term EU-UK relationship could take many years. We expect 1.6 per cent growth this year and next.

The Bank of England is minded to raise rates again, fearing that falling unemployment might push up wages and inflation, but it is also watching the Brexit impact on business and consumer confidence, the housing market and investment.

However, a Brexit deal may simply replace one form of political uncertainty with another and the Bank too could miss its window to tighten further. The longer an agreement takes, the more likely that UK rates don’t rise in 2019.

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The world trades down
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