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Euro area
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The Euro area: moderate slowdown
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The Greek crisis continues to be the focus of attention in the euro area.
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The Greek situation is once again the focus of attention in the euro area. The slowness of negotiations among the members of the European Union regarding Greece's solvency crisis, together with the paralysis of the Greek parliament, have led to further disruption in the financial markets. Moreover, this might affect the real economy as a result of greater uncertainty over the coming quarters.
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The Greek situation can be summed up in a few words. The European Union postponed the fifth payment of the financial bail-out (12 billion euros) while calling upon the Greek parliament to pass its medium-term fiscal strategy, consisting of a programme of privatization and additional fiscal austerity measures, supposing larger cuts in government spending. The Greek prime minister, Papandreou, proposed a unity coalition government, which was rejected, changed the finance minister to Evangelos Venizelos and overcame a vote of no confidence. He also proposed a national referendum to calm down the rest of Greek society. This referendum, which will be in the autumn, will propose, among other measures, a change in the constitution to cut back the privileges of the political class, alter the party funding system and reduce the size of the public sector.
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Economic recovery consolidates in the euro area.
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Fortunately, this crisis is occurring within a scenario of economic recovery, as highlighted by the breakdown in growth of gross domestic product (GDP) for the first quarter in the euro area. Given the good figures for economic activity, several financial organizations have upped their GDP estimates in 2011 for the euro area. For example, the International Monetary Fund (IMF) has raised its forecast by four tenths of a percentage point to 2%, and the European Central Bank (ECB) has increased growth by two tenths of a percentage point to 1.9%.
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In fact, private consumption has consolidated its growth around 1.0% in the last quarter. Although this is still slow, it must be interpreted as positive within the context of household deleveraging. Gross fixed capital formation has picked up more strongly. Thanks to manufacturing orders, European investment grew by 4.2% year-on-year in the first quarter. Curiously, and in spite of the fiscal austerity plans, public consumption has also picked up to 1.1%. Public consumption will have to take a more moderate path over the coming quarters to comply with the fiscal consolidation in which most European countries are currently immersed.
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In addition to the improvement in investment is the consolidation of consumption and good performance by net exports.
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All this is happening within an environment where leading macroeconomic indicators point to a slight slowdown in the pace of growth for the euro area as a whole. This situation is due to two reasons. Firstly, some countries have seen extraordinary growth in the first quarter that is not sustainable in the long term. This is the case, for example, of Germany, announcing 4.9% growth year-on-year in the first quarter. On the other hand, the slowdown in growth that has also been seen in the United States, Japan and China, as well as in most emerging countries, should slow up the rate of net exports from Europe. This slight slowdown is not worrying but merely a fall towards more reasonable growth rates given the current situation.
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Industrial production continues at cruising speed.
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For example, industrial production advanced by 0.2% in April in quarter- on-quarter terms and its figure for the previous month was also raised. This leaves the year-on-year rate at 5.2%, slightly below the figure posted for the first quarter (6.6%). If we analyze the breakdown by sector, all show slight quarter-on-quarter growth, such as capital goods(0.5%) and durables (1.3%), the only exception being the energy sector, down -3.7%). The reason behind this fall is partly the relatively warm temperatures in April in Europe.
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Entrepreneurs seem optimistic thanks to exports.
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In summary, manufacturing production has remained at a high level and it's normal that, after the upswing in 2010, this should fall back to levels more consistent with the growth in the world and the euro area itself. The effect of this good performance by the industrial sector can be seen in the business sentiment surveys which remain at high levels, in spite of falling slightly compared with the previous month, affected by rising oil prices and Greek instability.
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However, consumer confidence, although improving on its figure for May, has stabilized in a narrow range since the middle of last year and has still not reached its pre-crisis level. The higher optimism among entrepreneurs than consumers is due to the good performance by exports of European manufacturers. In contrast, the slowness in the unemployment rate falling continues to dampen the confidence of households.
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The slowness in creating jobs places a ceiling on the improvement in consumer confidence.
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In April, the unemployment rate remained unchanged compared with the figure for the previous month, namely 9.9%. Until the trend in job creation improves, European consumers are unlikely to abandon their caution. And the official statistics office, Eurostat, estimates that there were 15.5 million people unemployed in the euro area in April, although the number of unemployed has fallen by 457,000 people in comparison with the same period a year ago.
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Inflation easing is good news for households.
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Fortunately, for consumers in a situation of wage restraint, the good news is the moderation in inflation in May, down by one tenth of a percentage point compared with the previous month, to 2.7%. While fruit, milk and meat continue to push up inflation, only vegetables fell in price, perhaps due to the food contamination experienced especially in Germany. We have perhaps hit the peak for inflation this year, providing there is no upswing in oil prices or other food commodities like the one occurring over the last 12 months.
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Net exports reduce their contribution to European growth.
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On the other hand, the downward trend in the foreign sector's contribution to European growth continues. This can be seen in the figures for the euro area's trade deficit in April, rising to 4.1 billion euros, a sharp rise compared with the same period last year, when it had a surplus of 0.7 billion euros. One of the main reasons behind this change is the large increase in imports due to higher oil prices.
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Summarizing, economic indicators point towards a slight slowdown in economic activity for the second quarter compared with the surprising growth of the previous quarter. But this in no way raises doubts regarding the economic recovery of the euro area as a whole, although geographical disparities remain within the zone. The greatest risk over the coming months lies in the peripheral countries and in particular in Greece.
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If the Greek crisis takes much longer to resolve and a high level of uncertainty remains, this could affect economic activity resulting from higher financing costs via wider public debt differentials for those countries with a doubtful fiscal situation. We should remember that, over the next few quarters, the contribution of public expenditure will fall in contrast to the growth seen in the first quarter. For this reason, any factor slowing up the consolidated trend in consumption or reducing investment would also reduce the euro area's growth.
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Economic indicators point to a slight slowdown in the second quarter.
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However, our main scenario, which contemplates a resolution of the Greek crisis, supports the higher growth forecasts given by supranational organizations, as the rate of growth for the euro area this year and leading indicators point to growth being around 1.9%.
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The Greek challenge will be a significant factor that will determine the path taken by growth.
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The key to a negotiation lies in all participants feeling they have improved their position, in contrast to the alternative scenario of not reaching an agreement. There's a lot at stake for Europe, given the possible scenarios for resolving the Greek financial crisis. Greek politicians are also aware that their country's future will be decided over the next few months. Faced with such challenges, in the past Europe has proven its ability to deal with public issues by achieving the best outcome. This crisis should not be any different to the previous ones.
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Germany
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The German economy loses a little steam
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The trend in economic sentiment indicators points to a moderation in German growth after the strong boost to GDP in the first quarter. Domestic demand continues to take over the reins. On the other hand, the negative output gap has narrowed; i.e. GDP is now at the level of its non-inflationary potential.
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With regard to domestic demand, consumption continues to be boosted by job creation and rising income. In fact, the unemployment rate fell again in April and looks likely to continue falling. However, in May the BA-X indicator for employment demand slipped slightly. Within this context, in the same month car sales were up 22% compared to twelve months ago, the highest year-on-year rate since October 2009. Consumer confidence improved slightly in May, consolidating at high levels, suggesting that consumption will continue to expand considerably.
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The negative output gap narrows in the German economy.
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For its part, investment looks dynamic in general. Production capacity utilization is above the long-term average, there are good profit expectations and low interest rates are encouraging investment in capital goods. Investment in construction is also looking vigorous.
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Good prospects for construction.
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With regard to the foreign trade of goods, this will probably slow down its growth after reaching a peak in March. In fact, in April both the exports of goods and imports fell compared with the previous month, once adjusted for seasonal and calendar effects. Exports are aiming increasingly towards the more dynamic emerging economies, rising by 13.4% compared with April 2010. However, the rise in imports was notably higher in the same period, namely 20.1%.
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From the point of view of supply, industrial production saw a slight decline in April but its year-on-year rate of change was high. Moreover, industrial orders were up in the same month. However, on the whole industrial production is likely to slow down in the next period. For its part, construction looks healthy. Both building permits for housing and new orders are growing, suggesting sustained activity for this sector in the future.
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The economy's dynamism is accentuating the trend in wage increases. However, for the time being this is not worrying, due to the growth in productivity. The rate of inflation has remained below the average for the euro area and fell by one tenth of a percentage point in May to 2.3% year-on-year, posting the first drop in 9 months, mostly due to the fall in energy prices. Nevertheless, the rate of inflation is now above 2%, although this can fundamentally be put down to rising energy commodity prices in the last period. Our forecast for the coming year is of a certain slowdown in inflation.
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In summary, for the second quarter we expect more moderate quarter-on-quarter growth of around half a point and we keep to our forecast of a 3.3% annual rise in GDP for 2011. Strong inertia ensures a long expansion. However, downward risks can also be seen due to possible financial disruption.
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France
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France: improvement in the labour market confirms its economic expansion
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The trend in wage increases gets stronger in Germany but is offset by growth in productivity.
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After strong growth in the first quarter, the French economy seems to be continuing its expansion in the second, albeit at a slower rate. The push is coming mostly from private consumption and investment. Available indicators are compatible with the quarter-on-quarter growth forecast of half a percentage point. We have therefore not altered our forecast of a 2.2% annual rise in gross domestic product for 2011.
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The French economy continues to expand, albeit at a slower rate.
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In April, the consumption of manufactured goods by households fell notably compared with the previous month, due to durables and particularly cars. However, in May consumer confidence improved slightly thanks to the sustained dynamism of the labour market and inflation easing back. Passenger car registrations therefore accelerated and posted a year-on-year rise of 6.5%.
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With regard to the foreign sector, in April the current account deficit widened after its improvement in March. The deterioration in the trade balance was greater than the slight improvement in the services surplus. This record trade imbalance was pressurized by rising prices for energy products but also reveals problems of competitiveness, brought into sharper relief by a strong euro.
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On the supply side, industrial production fell slightly in April and the year-on-year rate of change slowed up to 2.6%. Similarly, new industrial orders fell in March. However, the level of order portfolios was above the long-term average, ensuring a notable pace of activity in the secondary sector over the coming months. For its part, construction is looking extremely lively. Lastly, although the climate for services worsened slightly in May, its level was optimistic, pointing to expansion but to a lesser degree.
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The European Commission recommends the French authorities rigorously apply measures to correct the excessive public deficit.
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The economy's dynamism is reflected in the labour market. In the first quarter, salaried employment in the market sectors rose by 1.1% compared with the same period the previous year. In April, the number of people looking for employment posted a drop for the fourth consecutive month, confirming the exit from the crisis, and the unemployment rate fell slightly to 9.4%. In line with this, wages have picked up their rate of increase. However, consumer price inflation fell by one tenth of a percentage point in May to 2.0% due to the turnaround in energy prices that month.
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Other indicators also show the improved tone of the French economy. There's a downward trend in the number of business failures and, in May, the number of new start-ups picked up. Similarly, in April the recovery in credit to non-financial firms consolidated, of note being the large growth in credit to SMEs. Within this context of economic improvement, the bill was presented to rectify Social Security for 2011, containing a lower deficit than the one projected in the initial proposal. On the other hand, this law establishes that employees in firms with more than 50 people on the payroll and whose shareholder dividends have increased compared with the last two years can benefit from a premium that would be set in line with collective bargaining.
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Nonetheless, the European Commission, in its recommendations regarding the 2011-2014 stability programme, believes that the macroeconomic scenario on which the budget projections are based is too optimistic and recommends rigorously implementing the measures to correct the excessive public deficit by 2013 at the latest. In this respect, it states that the viability of the pension system needs to be examined. Moreover, it encourages the country to combat the segmentation of the labour market and to promote access to training in order to help older workers remain in active employment.
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Italy
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Italy: timid signs of recovery in household consumption
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Italian consumer confidence improves in May as inflation becomes contained...
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The detailed figures from the National Accounts system for the first quarter confirmed modest quarter-on-quarter growth in GDP of 0.1%, the same as in the previous quarter. Household consumption contributed one tenth of a percentage point to this increase, public consumption another tenth and investment's contribution was zero, while inventory changes subtracted 0.3 percentage points. For its part, foreign demand contributed two tenths of a percentage point, after having subtracted six in the fourth quarter of 2010.
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...but business sentiment worsens.
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The latest indicators available for the second quarter point to some recovery in household consumption. In April, the production of consumer goods posted a positive year-on-year rate for the first time in seven months. Automobile sales also posted a year-on-year rise in May for the first time in fourteen months. And this movement might continue, looking at the improvement in consumer confidence in May. This trend was boosted by contained inflationary pressures in the same month. However, the seasonal situation of the labour market does not give much room for consumer optimism.
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However, business sentiment saw a slight drop in May in almost all sectors. Given that industrial capacity utilization is also lower than the long-term average, growth in investment will probably be slow.
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On the supply side, industrial production increased in April and in the first quarter posted a year-on-year increase of 2.5%, after adjustment for calendar effects. For its part, order books increased by 15.2% in the period January-April compared to twelve months earlier. In April, the highest increases went to chemical and metal products, thanks to the boost provided by foreign demand. Although industrial confidence fell a little in May, the level of orders guarantees a period of expansion in the secondary sector.
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In all, it seems that Italy's economic growth for 2011 will be similar to that posted in the first quarter, namely 1.0% year-on-year. This low rate of growth in activity and the high level of public debt are causing some concern in the markets. At the end of the fourth week of June, the risk premium for Italian public debt measured in terms of its differential with German ten-year bonds stood at 199 basis points, the highest since the start of the euro, although affected by the Greek crisis.
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Ratings agencies give Italian debt a negative outlook.
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Within this context, the ratings agency Standard & Poor's changed its outlook for Italian debt from stable to negative on 20 May. Similarly, in mid-June the agency Moody's warned that it might cut the rating of Italy's long-term debt, placing it at Aa2. In fact, the setbacks suffered lately by the government in the municipal elections at the end of May and in the referendums in mid-June are not helping it to undertake the reforms being demanded by the markets.
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Within the framework of its review of Italy's updated 2001-2014 Stability Programme and National Reform Programme, the European Commission made a series of recommendations to improve the economy. Firstly, it stressed the need to ensure the planned fiscal consolidation. Among other reforms, it has pointed out the appropriateness of combating the segmentation in the labour market and matching wage rises to productivity more closely. It also suggests that services should be more liberalized and private sector investment in R&D encouraged, as well as reducing the persistent disparities between regions.
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United Kingdom
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The United Kingdom: a languid summer
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Macroeconomic indicators point to a weak recovery.
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The Met Office of the United Kingdom used to provide a forecast of the weather that could be expected throughout the summer. It only recently withdrew this service after announcing a 'barbeque summer' in 2009 (because of the good weather the country would enjoy), which ended up being one of the rainiest summers since official records began. We don't dare give a weather forecast for those planning a visit to the United Kingdom but we can confirm that macroeconomic indicators point towards a languid summer in terms of economic activity.
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The IMF believes that the United Kingdom is applying the right economic policy.
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Moreover, the United Kingdom is at a disadvantage in its recovery because, after analyzing the composition of growth in the first quarter, this turns out to be disappointing in quality terms. In fact, although the year-on-year rate remained at 1.8%, the breakdown by component is of some concern. Private consumption fell by 0.6% quarter-on-quarter, reflecting the weak domestic demand while investment also shrank by 4.4% quarter-on-quarter. In fact, it was the expansion in exports (3.7%) that boosted GDP, together with the fall in imports (2.3%), another symptom of weak domestic demand.
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Even the UK's central bank, in the minutes of its meeting held in June, recorded the disappointment of the members of the monetary committee that the weakness in demand would last longer than initially expected. Certainly, the macroeconomic data point to this situation. Firstly, we have the slowdown in retail sales in May, with the month-on-month figure falling by 1.4%, placing the year-on-year rate at 0.2%, compared with 1.5% in April. May's figure is the worst in the last year and a half. And May's inflation remains anchored at 4.5% year-on-year, reducing the net disposable income of British consumers within a context of strong wage restrictions.
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On the other hand, manufacturing production also fell sharply in April by 1.5% month-on-month, although special effects such as Japan's tsunami harmed the figures and these will probably see some recovery in the next few months. But, on the whole, all economic indicators are discreet and suggest that the recovery in the British economy will take its time to get going.
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To date, emerging Europe has escaped the global slowdown in activity...
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However, one piece of good news is the consensus in the different supranational organizations, such as the International Monetary Fund, recognizing that the economic, fiscal and monetary policies being applied are appropriate, although the medicine has yet to have an effect on the organism. Irrespective of the weather this summer in the United Kingdom, this holiday period is a time when not only students who need to review the subjects they have failed but even good students could take advantage of the time to further their training. The United Kingdom is a good student because it's doing its homework, although it's not getting such good marks at present. However, the secret of students who really apply themselves is perseverance.
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Emerging Europe
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Emerging Europe: resisting the ravages of slowdown, inflation and financial contagion
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For the moment, emerging Europe is managing to elude a growing phase of economic and financial uncertainty. When we look at three vital issues - the scope of the global slowdown in growth, the degree of financial contagion from the Greek sovereign debt crisis and the inflationary trend - in all three cases we end up concluding that this region has avoided an openly negative impact so far. Let us look individually at these three fronts in the global economic situation.
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With regard to the slowdown in activity, the figures point to a moderate and probably temporary effect on the countries of central and eastern Europe. One initial element in their favour within this sphere has been the excellent rate of growth in GDP for these economies in the first quarter, exceeding the forecasts given, in themselves positive. Specifically, the five states we usually monitor in this report (Poland, Hungary, the Czech Republic, Slovakia and Romania) have posted higher growth figures compared with the fourth quarter of 2010. The main support for this expansion, in general terms, comes from strong exports.
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Little evidence of financial contagion by Greek debt, in any case limited to Romania and Hungary.
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Going forward in time, we should ask ourselves whether the second quarter can maintain this upswing in activity. Indicators of economic sentiment, highly sensitive to cyclical changes, suggest that, up to May, activity has remained along the same lines as the first quarter. Slovakia and Romania have recorded advances in these indicators, while in Poland, Hungary and the Czech Republic the average levels for April and May point to a very restrained slowdown in activity. Adding these trends to the forecasts we have for the euro area, and particularly Germany, which point to a clearly expansionary 2011, we believe that the main scenario for emerging Europe will remain the same as for the last few months: it will be a positive year with growth speeding up in all economies and, in some cases, such as Poland and Slovakia, reaching notable figures, above 4%.
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The second of the points demanding attention at the moment refers to developments in the Greek sovereign debt crisis and its repercussions on the financial markets of emerging Europe. Looking at the values of national currencies and Credit Default Swaps for sovereign debt (which measure the cost of insuring a hypothetical default on these bonds), there is no evidence of contagion in the case of Poland, Slovakia and the Czech Republic, and any effect is small in the case of Romania and Hungary.
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Although inflation is still high, close to 5% in May, it is expected to ease over the coming months...
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In these last two countries, the markets are probably concerned about two very different sources of contagion. In Romania there is a direct channel whereby it could be affected by the financial crisis, as approximately 20% of the country's banking market is dominated by subsidiaries of Greek credit institutions. Given this fact, there is the concern that any possible harm to the balances of these banks' parent companies due to the hypothetical rescheduling of public debt might end up affecting the subsidiaries' capitalization. Hungary, however, continues to be burdened by the perception that the government has yet to fully regain its fiscal credibility after a 2010 with excessive ups and downs in this sphere. We repeat, however, that both countries are facing a situation of contained financial repercussions, far from what is being experienced by other nations.
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Lastly, the third of the aspects we mentioned previously, namely inflation, might be on the brink of being redirected, although we cannot say it has been resolved. And although the latest figures available are far from encouraging (in May, the average harmonized inflation in the five economies in question stood at 4.6% year-on-year, the highest since mid-2008), the forecasts suggest we might be close to the start of a gradual slowdown in prices. The downward trend in food commodity prices over the last few months will help the food component in the consumer price index (CPI) to ease back. This is a significant development, especially as it is precisely this component that is being more expansionary (this aggregate reached 9.1% of the year-on-year increase in May).
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...which, added to the absence of signs of overheating, mean that monetary policy can gradually get back to normal.
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Beyond expectations of an imminent improvement in the CPI, this inflationary episode is occurring within a context that reduces the situation's significance. In contrast with other emerging economies, the ones mentioned here are showing few signs of economic overheating. With the exception of Poland, the recovery in domestic demand has hardly started. Neither does there seem to be a problem of scarce resources in the factor markets, as the labour market continues to have relatively high levels of unemployment while the degree of available production capacity utilization is still extensive. The absence of tension in terms of sharp appreciations in national currencies completes our diagnosis of a lack of economic overheating. This should mean that monetary policy can get back to normal gradually, without the demands being forced upon other emerging economies.
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