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Euro area: consolidating recovery
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In 2010 the euro area will consolidate its recovery...
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The euro area is facing 2010 in much better shape than it started 2009. At that time the financial crisis was at its peak and business was plummeting further than it had in decades. It was difficult to imagine that such a change could come about in just one year. The financial sector has stabilized significantly, there has been a sharp upswing in confidence and economies are growing again. In the third quarter, the euro area posted quarter-on-quarter growth of 0.4%. In year-on-year terms, however, the rate of growth is still being hindered by the strong setbacks it experienced a year ago, so that year-on-year growth is still negative, specifically 4.1%.
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...but we don't expect growth to be too vigorous.
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This trend will continue in the short term, with year-on-year growth getting back into positive figures in the first quarter. Recovery, however, will be slow. In 2010, the gross domestic product (GDP) of the euro area will find it hard to grow much more than 1% and we don't expect growth rates of between 1.5% and 2%, more in line with its growth potential, to be achieved until 2011. Such a slow recovery will mean that the euro area will take several years to return to its pre-recession levels in terms of GDP.
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The process of coming out of recession is supported by the foreign sector...
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A breakdown by growth component in the third quarter reflects the strengths and weaknesses of this recovery. Coming out of recession depends fundamentally on the foreign sector and economic stimulus plans. An example of this is the upswing in the volume of trade, which hadn't seen positive quarter-on-quarter growth for more than a year. Exports are pushing forward with 2.9%, 5 tenths of a percentage point above the rise posted by imports, while the foreign sector's net contribution to growth was 2 tenths of a percentage point.
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...and economic stimulus measures.
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The effect of economic stimulus measures is more difficult to determine. These are partly behind the 0.5% rise in expenditure on public consumption, which contributed one tenth of a percentage point to growth. But these measures have also helped to curb the drop in investment. After losing 4.9% in the first quarter and 1.7% in the second, in the third quarter this only fell by 0.4%, less than initially forecast. We expect this trend to continue in the short term. For example, this is indicated by the PMI (purchasing managers' index) which, although slowing up the rate at which it was increasing, continued to improve in December.
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Consumption continues to show signs of weakness.
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The downside still lies with consumption, falling two tenths of a percentage point compared with the previous quarter and with no positive growth for the last 6 quarters. This weakness in consumption is reflected in poor retail performance which, after a 3.1% fall year-on-year in the first quarter, has fallen by more than 2% in both the second and third quarter. In the month of October retail sales fell by 1.8%, so that no change in trend can be seen for the moment. Another indicator of weak demand is core inflation. In the month of November this continued its slow but substantial downward slide, now standing at 1%, particularly due to the fall in food prices, down 1.2%.
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Throughout the year, the strong and weak points of the economy in the euro area will gradually swap over: first investment and then consumption will start to take over the economy. Trade volumes will continue to rise but improved consumption will mean that imports grow faster than exports, so the net contribution of the foreign sector will become negative.
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Public accounts will deteriorate significantly in 2010.
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On the other hand, the effects of economic stimulus measures will still be positive, although the sharp deterioration in public accounts in 2009 means that these won't be extended much further. In fact, it is very likely there will be increasing pressure for far-reaching reforms to be carried out in some countries. The sharp drop in fiscal revenue, particularly in countries that were highly dependent on just a few sectors, together with higher expenditure related to automatic stabilizers, has raised public deficits and public debt to historic levels.
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Greece and Ireland are the most heavily affected.
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The countries most affected at present are Greece and Ireland. Greece has seen its two main sources of revenue plummet: tourism and trade. The government has had to revise its deficit estimates for 2009 from 6% to 12.7% and the Commission predicts that it will remain at this level in 2010 and 2011. For the first time in 10 years, the Fitch rating agency gave Greece a rating of BBB+, a lower level that reflects its worsening sovereign risk. Its starting point for public finances was not so good either. Greece's level of public debt as a percentage of GDP has not fallen below 100% for the last decade and the European Commission's forecasts place it above 120% in 2010.
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The starting point for Irish public finances was better, as its level of public debt as a percentage of GDP in 2007 was 25%. Thanks to this, the Irish economy has been able to better withstand a threefold collapse: that of the financial system, which has been nationalized, that of the real estate sector and that of international trade. The extent of the impact was perfectly reflected in the falling GDP, this reaching 9.1% year-on-year in the first quarter. The consequent deterioration in public accounts has also been historic: public debt as a percentage of GDP exceeded 50% in 2009 and the European Commission predicts it will be around 80% in 2010.
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The level of debt alone does not tell us whether a country can repay its debts or not. Another figure to take into account is the growth forecast for the coming years, but this does not promise to be very buoyant in either case. Analysts are also keeping their eye on other countries, such as Italy and Portugal, both expected to enjoy moderate growth but with a high level of public debt.
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In fact, the level of debt in the different countries of the euro area will be the focus of many economic debates throughout 2010. But other points will also be of interest that we have already discussed in previous issues of the Monthly Report, such as the possible surge in unemployment and the process of withdrawing monetary expansion policies. In short, there is no doubt that the euro area as a whole is facing 2010 with significantly better prospects than it had a year ago, although its recovery promises to be complicated and will surely provide us with a surprise or two.
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