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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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