Research Dept. News
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Monthly Report, num 285 - November 2005
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European Union - Euro area
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European Union: recovery taking shape but inflation threatens
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Conclusion: as 2005 ends, incipient recovery under way…
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As we come close to the end of the year, more and more evidence is available to confirm recovery in the euro area. Supply indicators, which are much more sensitive to cyclical swings, have been showing this economic recovery since the beginning of summer. The most general of all indicators, that for economic sentiment, marked up an annual low last June but later added 2.3 points as of September. This increase was the result of an improvement in confidence in all sectors –industry, services and construction.
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…given that both supply indicators (with notable figures in industrial production)…
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Following on the qualitative indicators, based on surveys of economic players, have come real figures, among which we should mention the trend in industrial production, which first of all consolidated its gradual recovery in June and July (with growth of 0.7% and 0.5% year-to-year respectively) to later move up to 2.7% year-to-year in August.
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The most hopeful news, however, comes on the side of domestic demand. Industrial production of capital goods had already shown a more expansionist performance of corporate investment (growth of the order of 2% year-to-year from June to August). Now the main component lacking from the recent European cycle is beginning to show up in less depressed household consumption.
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…and demand indicators (with new factor that consumption seems to be leaving behind slack stage) point to recovery.
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While we cannot yet say the weak stage of consumption is all over, some key indicators are beginning to look better. The rise in retail sales, especially appreciable in August, and car registrations (which have run up three very positive months from June to August) would confirm the better state of households.
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Nevertheless, the persistent weakness of consumer confidence presents a troubling other side. The definitive consolidation of consumption will have to wait until employment proves more dynamic (it grew by a mere 0.7% year-to-year in the second quarter) and until the unemployment rate moves away from present levels (8.6% of the labour force in August).
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Rundown on risks: one, loss of strength in exports, while not alarming, does complicate overall scene…
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Having reviewed the more favourable elements on the economic scene, it is worth paying attention to two less promising factors: the recent weakening of foreign demand and the rise in inflation. The contribution of the foreign sector has been negative since the third quarter of 2004 and further worsened in the second quarter of 2005. Figures for the trade balance in recent months show that imports continue to grow above exports, partly the result of the higher level of domestic demand mentioned above, so that the cumulative trade balance for 12 months in August was 46% lower than one year earlier.
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…two, inflation jumps to 2.6% because of oil with effects over medium term troubling…
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With regard to the threat of inflation, this gained much attention in October. Latest available figures allow for a fairly broad interpretation. The harmonized consumer price index (HCPI) stood at 2.6% year-to-year in September. This is four decimals higher than the August figure and the highest recorded since January 2002. Nevertheless, if we take the energy component (which rose by 15% year-to-year in September) off the general index, the resulting rate shows an increase of 1.4% year-to-year, merely one decimal higher than in August.
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…such effects likely to take place, thus limiting growth potential as of second half of 2006.
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The European Central Bank (ECB), working in its role of guarantor of price stability in the euro area, has stated its concern about the rise in oil and its effect on prices, both current prices and especially future prices. What is troubling is that high energy prices could end up shifting to more permanent increases in overall prices in the economy, something known as «second round effects». This led the chief economist of the ECB, Otmar Issing, to state that, while official forecasts of the central bank continue at 1.9% for 2006, he considered it likely that inflation would end up standing above 2%, the central reference rate of the common monetary policy. On the other hand, Joaquín Almunia, the European Commissioner for Economic Affairs, denied that we were at the beginning of an inflationary spiral and that the recovery now under way is not in any way threatened.
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What is our position? In view of oil prices that are still high and with no clear prospects of correction to be seen on this front, «second round effects» will indeed end up taking place, perhaps less sharply than they have in the past. This lesser impact may be explained by changes in the institutional environment of the economy (credible anti-inflationary policy of central bank officials and less shifting of inflation to wages thanks to reduced indexing, etc.). The effect will be appreciable not so much in the immediate recovery in coming quarters as over the longer term. As a result, although we foresee that the euro area will increase its growth rate so that in the first half of 2006 it goes to levels of increase in the gross domestic product (GDP) of the order of 1.8% year-to-year, from then on we likely will move into a stage with a lack of growth stability.
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