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Euro area
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Uncertainty takes hold of the euro area
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The uncertain Greek situation continues to weigh heavily on the economic climate.
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In Greek mythology, Sisyphus was the founder and king of Corinth. Because of his impiety, the gods punished him in hell by making him push a huge boulder up a steep hill but, before he could reach the top, the boulder always rolled back down and Sisyphus would have to start all over again. And the Greek situation is starting to resemble this myth, as there seems to be no way to break the loop of uncertainty that has taken hold of the euro area.
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Given the situation of the sovereign debt crisis in Europe, economic managers have expressed all kinds of opinions and suggestions.
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The second financial bailout plan seemed to be enough to resolve Greece's problems but doubt surfaced regarding the country's capacity to achieve the new targets. Given this problem, the Greek finance minister, Evangelos Venizelos, decided to approve supplementary taxes to fill the fiscal gap.
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Greece is willing the make all the effort necessary but is still facing big challenges.
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On 19 September, via a joint conference, Venizelos and the permanent representative for Greece of the International Monetary Fund (IMF), Bob Traa, stated the seriousness of the situation and the importance of speeding up the restructuring of the Greek economy.
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Finally, at the end of September, the troika made up of the International Monetary Fund, the European Central Bank and the euro area, decided to send a review mission to Greece to report on the country's situation at first-hand. This is a necessary condition before taking the decision whether to release the 8 billion euros of the sixth tranche of the international loan approved in May 2010.
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On the other hand, the economic environment is not helping the country, with all the economic regions in the world experiencing a downturn at the same time. And the euro area is no exception. In fact, the breakdown of data on gross domestic product (GDP) is now available for the second quarter and this slowdown can be observed in all subcomponents, without exception.
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Household consumption and business investment have been hit by uncertainty regarding the outcome of the sovereign debt crisis. This has pushed up financing costs and has even led to a credit squeeze in some segments, resulting in investment and household consumption being postponed.
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Slowdown in economic activity for the euro area as a whole.
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On the other hand, the fiscal restriction policies implemented in numerous countries in the euro area have resulted in growth of just 0.3% year-on-year in public expenditure. Lastly, the slowdown in the rest of the world has affected Europe's trade with a substantial drop in export growth. In short, the euro area's economy is growing by 1.8% year-on-year, very close to our growth forecast for this year of 1.7%.
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Macroeconomic indicators point to moderate growth for the next two quarters.
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It's difficult to predict an acceleration in growth during the third quarter when flash macroeconomic indicators point to moderate growth. Consumer and business confidence certainly deteriorated during the months of July and August and it's evident that those surveyed must have been affected by the high uncertainty caused by the sovereign debt crisis. This has led to great volatility in the financial markets, resulting in very pessimistic newspaper headlines.
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But some economic data are positive: industrial production and job creation.
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However, not all economic indicators have been negative. For example, July's industrial production in the euro area rose by 1% compared with the previous month's figure, according to data published by Eurostat. Between June and July this year the production of capital goods grew by 3.0%, while consumer durables were up 2.9%. In year-on-year terms, industrial production saw growth of 4.2%; although it's true that these figures hide extensive geographical heterogeneity. While Germany is enjoying 10.4% year-on-year growth in its industrial production, countries such as Greece and Ireland are seeing falls of 2.9% and 4.9%, respectively.
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Paradoxically, there are two factors generated by the current crisis that should help Europe's economic activity over the coming quarters. Firstly, the depreciation of the euro reflected in the fall of the currency's nominal effective exchange rate. Secondly, the drop, albeit very moderate, in oil prices is also a factor positive. For example, since April this year, when a barrel of Brent quality oil peaked at 127 dollars, the price of crude has fallen by around 11%.
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In the coming quarters, the Greek problem will not disappear, so further intense outbreaks of volatility cannot be ruled out.
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These two elements are positive because they boost European exports and reduce energy costs. In both cases, the trade balance and industrial production aimed at exports will benefit, as well as job creation indirectly. Although the unemployment rate remains stuck at around 10%, job creation in the euro area in the second quarter was 0.3% year-on-year, according to Eurostat. This figure is up on the jobs created in the previous two quarters, which was just 0.1%, indicating a profile that is adjusting with the economic activity data available to date.
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The Greek situation will continue to monopolize the headlines in the coming quarters. Hence the comparison with the myth of Sisyphus, which the poet Homer reminds us of in Book XI of the Odyssey. Fortunately, the hero Ulysses gets back home, albeit after numerous ups and downs, a positive ending we hope will be the same for the Greek situation. Although the return journey is bound to provide further chapters for the country, which is facing a huge challenge, namely substantially restructuring its economy, as it has been reminded by the IMF.
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Germany
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The German economy overcomes its dip in the second quarter
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The deterioration in the global climate has led to growth forecasts for the German economy being revised downwards, especially for 2012.
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After the sharp downturn in the second quarter, when it posted a meagre 0.1% quarter-on-quarter growth, it seems as if the engine of Europe has livened up over the summer, with the boost mostly coming from domestic demand. However, the German economy can't completely escape the slowdown in the world economy and the turbulence in financial markets, and this has been reflected in the latest indicators for the economic climate, posting a notable deterioration. The International Monetary Fund recently revised its forecast for German GDP in 2011 by half a point in comparison to June, down to 2.7%, and lowered its forecast for 2012 by 7 tenths of a percentage point to 1.3%.
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Regarding demand, consumption seems to have livened up to some extent. In August, automobile sales rose by 18.3% compared with the same month the year before and the favourable trend in the job market supports consumption's contribution to growth. In July, the number of employed rose by 1.4% compared with the same month last year and the seasonally adjusted number of unemployed continued to fall, albeit at a slower rate. Moreover, in August the BA-X indicator for job demand picked up.
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The favourable trend in the job market supports consumption.
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However, consumer confidence continued to weaken in August, although standing at a relatively high level. Inflation remained above 2% for the seventh consecutive month, mainly due to the rising price of energy, and made consumers cautious.
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Investment, however, continues to progress. In July, the industrial production of capital equipment was up 7.5% compared with the previous month. However, the sharp fall in the IFO indicator for the business climate points to a moderation in investment, although this is above its historical average.
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The trade surplus shrinks in July.
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With regard to the foreign sector, in July the current account surplus posted a 28% year-on-year drop to 7.5 billion euros. This was particularly due to the trade surplus shrinking. In any case, foreign demand is expected to make a positive contribution to GDP growth but there is the risk of world expansion moderating.
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From the point of view of supply, the pleasant surprise was provided by industrial production in July. In fact, manufacturing production rose by 4.5% on June, adjusted for seasonal factors and calendar effects, reaching a peak and, for the first time, exceeding the level prior to the crisis. In the period of June-July, it posted a year-on-year rise of 10.0%. However, new industrial orders dropped off in July and, although the trend is still upward, this eased in pace, so that industrial production is likely to moderate in the coming period.
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In August, unlike industry and services, confidence in construction improved and stood at a notably high level. In fact, in July the production of construction rose by 3.2% compared with the previous month. With regard to services, in the same month hotel stays were up 1% compared with the previous twelve months, particularly due to foreign demand.
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Industrial production provides a pleasant surprise in July but the outlook is one of moderation.
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The good performance of the German economy is reflected in its public accounts. In the first half of the year, the government deficit fell to 0.6% of GDP compared with the 3.1% recorded in the same period of 2010. This trend was due to a year-on-year increase in revenue of 6.0% and only 0.3% in expenditure, of which investment costs rose by 8.1%.
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On the whole, the German economy has got its strength back. Its underlying fundamentals are solid and the expansion seems confirmed. However, growth will tend to slow up after the upswing in the third quarter.
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France
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Little dynamism in the French economy in the third quarter
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French consumer confidence falls within a context of slightly rising unemployment.
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After the stagnation of France's gross domestic product in the second quarter, indicators available for the third quarter point to meagre growth in this period. This trend is the result, on the one hand, of the weakness in domestic demand and, on the other, of the deterioration in exports, affected by the downturn in the world economy after the rise in commodity prices and in particular due to the sovereign debt crisis in the peripheral countries of the euro area.
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French consumption looks sluggish. Consumer confidence has fallen in the last few months, affected by the upswing in inflation and the uncertain outlook in the labour market. Although salaried employment in market sectors rose by 1.1% in the second quarter in comparison with the same period of 2010, this still suggests a slowdown. In fact, the seasonally adjusted unemployment rate has risen slightly in the last few months to 9.9%, according to Eurostat's homogenized data. Nonetheless, new car sales were 2.0% up month-on-month in August, with a year-on-year rise of 3.3%.
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With regard to investment, the industrial production of capital equipment in the period May-July rose by 1.6%, seasonally adjusted, compared with the previous three months, above the figure for industry as a whole. However, the degree of production capacity utilization continued to fall off in August, below the historical average. Within this context, in the July business survey for manufacturers, they slightly revised downwards their forecast for nominal growth in investment in 2011 to 14%, albeit predicting a rise in investment in the second half of the year compared with the first.
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With regard to the foreign sector, which is suffering from some competitiveness problems, in the three months up to July goods exports dropped by 0.3% compared with the previous quarter, although they were 6.6% higher than the same period a year earlier. Sales to the rest of the European Union moderated while the rest showed greater dynamism. On the other hand, after their decline in June, imports picked up again and posted a rise of 10.8% in the period May-July compared to twelve months before. Purchases accelerated from the rest of the European Union, particularly Germany. Consequently, in July the trade deficit widened to 6.46 billion euros, coming close to May's level.
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French entrepreneurs revise investment forecasts down slightly.
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From the point of view of supply, July's industrial production figures provided a pleasant surprise after the drop in June, up by 1.5% month-on-month and by 3.7% year-on-year. However, the outlook points to production stabilizing in the short term, although the level of industrial orders was above the norm. With regard to services, August's overall survey showed a moderation in activity but this was expected to improve in the short term.
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On the other hand, credit to firms continued to flow to some extent. In July, the credit balance to non-financial companies posted a year-on-year rise of 5.0%, although manufacturers saw a fall of 1.1%. On the other hand, credit to SMEs saw slightly higher growth, namely 5.7% compared with July 2010.
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On the whole, indicators point to a modest rise in gross domestic product in the third quarter after the stabilization of the second. Given this context, and as a consequence of the contagion from the peripheral debt crisis, on 22 September 2011 the French government's risk premia for its debt hit a new record since the launch of the euro, at 89 basis points compared with German ten-year bonds. The government's difficulties in securing enough parliamentary support to introduce, in the Constitution, a mandate to limit public deficits did not help to improve the confidence of the financial market.
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The French government confirms the targets for public deficit cuts in spite of growth forecasts being revised downwards.
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However, the government confirmed its public deficit targets for 2011 at 5.7% of GDP and 4.5% for 2012. To this end, and given that it slightly revised downwards its economic growth forecast to 1.75% for both years, during the parliamentary proceedings it altered the adjustment measures announced in August. In addition to several cuts in spending, the plan is to bring in a new tax on overnight stays of more than 200 euros in luxury hotels.
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Italy
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The Italian government speeds up approval of its adjustment plan
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The Italian economy is saved by foreign demand in the second quarter.
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In the second week of September, the publication of details of Italy's National Accounts system for the second quarter confirmed quarter-on-quarter growth of 0.3%. This rate represents a slight acceleration and was mainly due to the push from exports, contributing 9 tenths of a percentage point, while changes in stock deducted 8 tenths of a percentage point.
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Consumption has looked weak in the first months of the third quarter. In July, the industrial production of consumer goods fell by 7.1% compared with the same month the year before. However, automobile sales improved in August, recording a year-on-year rise of 1.5%. Consumer confidence fell for the third consecutive month in August, affected by the lacklustre job market, whose unemployment rate refuses to drop below 8%, and by the upswing in inflation, which rose to 2.8% year-on-year the same month. Although the trend was expected to be downwards, the recently approved hike in value added tax will push up inflation to some extent in the short term.
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Investment continues to make progress. In July, the industrial production of capital equipment advanced by 1.8% compared with June, seasonally adjusted, and by 4.8% compared with one year earlier. However, given the downturn in the economic climate overall, investment is likely to slow down to some extent.
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With regard to the foreign sector, in July exports rose by 1.0% month-on-month, while imports rose by 1.6%, seasonally adjusted. On the other hand, the hotel sector performed well in August, thanks particularly to foreign tourism.
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Standard & Poor's downgrades Italy's sovereign debt rating by one notch to A.
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The view is also mixed from the point of view of supply. Industrial production fell by 0.7% in July compared with the previous month and by 1.6% in year-on-year terms, adjusted for calendar effects. However, confidence in the secondary sector picked up slightly in August thanks to the improved outlook for new orders. For its part, construction prospects improved slightly in July. Similarly, confidence in the tertiary sector increased in August thanks to services to firms, although retail was down.
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Within this scenario of little dynamism, the concern of financial markets for Italy's high level of public debt, accentuated by contagion from the Greek crisis, pushed up the risk premium again. On 22 September, the spread in yields of Italian ten-year government bonds compared with the same German bonds set a new record since the European single currency started, reaching 402 basis points, higher than the level for Spanish debt.
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Pressure from the financial markets led the government to toughen up some aspects and speed up approval of the summer's second adjustment plan. Among other measures, during the parliamentary proceedings to convert August's Decree Law into an Act, it also introduced a rise in the general value added tax rate to 21%. Moreover, a new solidarity tax was created up to 2013 for taxpayers with incomes above 300,000 euros and the retirement age for women in the private sector was raised as from 2014. The government, which faced a general strike in the second week of September, also made the labour market more flexible.
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In spite of the size of this new package, which involves a net reduction in debt of 0.7 billion euros in 2011, 22.7 billion in 2012, 29.9 billion in 2013 and 11.8 billion in 2014 in order to achieve a balanced budget by 2013, it might not be enough if risk premium levels persist remain high, due to the interest payments required on its large public debt.
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On the other hand, within the context of an economic downturn, partly due to the effect of budget consolidation, it is vital to regain competitiveness, so that further structural measures might be required. In this situation, on 20 September the rating agency Standard & Poor's downgraded Italy's long-term sovereign debt rating by one notch to A, with a negative outlook, while the Italian government is preparing a plan to stimulate growth via incentives for the private sector to build infrastructures, liberalizing services and increasing privatization.
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United Kingdom
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The United Kingdom: growth forecasts are revised downwards
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The storm is still rocking the boat of the United Kingdom in its journey towards a safe haven. The latest economic data have even led us to revise our growth forecast for gross domestic product (GDP) downwards for this year. Whereas our forecast was 1.6%, we have reduced this by five tenths of a percentage point to 1.1% for the whole of the year. However, we have maintained our 4.3% forecast for inflation. In short, a situation of less growth and high inflation, not a very encouraging panorama.
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The United Kingdom: negative economic figures are pushing down growth forecasts.
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The economic figures are clear. On the one hand, we have the data on retail and consumer goods for August, with year-on-year growth close to 0%. By component, it's interesting to note that food retail sales fell by 0.8% year-on-year while shop spending, excluding food, was down 1.3% year-on-year. These figures reveal the fragility of the household consumption trend; a weak pulse that will probably continue throughout the rest of the year. Households are trying to reduce their consumption given the drop in disposable income, hit by the fall in real wages, higher taxes and limited access to credit.
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Inflation remains high.
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Certainly, disposable income has been hit hard by stubborn inflation that remains at 4.5% year-on-year and might even rise above 5% in the next few months due to higher energy prices which will influence, with a slightly delayed effect, households' energy bills in the coming months. July's industrial production also fell by 0.7% year-on-year. The upturn seen last year, after the recession, is fading while firms are adjusting to more modest domestic demand and a decline in exports. This moderation in activity is leading to a slight deterioration in the job market, with the unemployment rate rising to 4.9% over the summer.
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Even the International Monetary Fund has commented that, depending on the pattern of growth, the authorities could postpone or relax the fiscal restrictions planned in order to avoid the risk of making the economic situation worse. In fact, this economic outlook has led economists to expect that the next move by the Bank of England might be expansionary in its quantitative easing programme; although certain scepticism still remains regarding the ability of this policy to kick-start the economy. However, due to the high level of inflation, expectations are that the reserve bank might wait until the beginning of next year to start this unorthodox expansionary monetary policy.
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The Bank of England might intensify its expansionary monetary policy.
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In summary, it seems that the economy of the United Kingdom will not be able to consolidate its exit from the recession, started at the end of 2008 and from which it emerged in the second quarter of last year. However, it will have another chance to do so next year, when inflation will fall considerably and fiscal restrictions will ease a little. In other words, the United Kingdom will be sailing under more favourable conditions next year. The important thing is to avoid any obstacles for what remains of this one.
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Emerging Europe
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Change in direction in emerging Europe
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Emerging Europe is embarking on a more prolonged and sharper slowdown than expected...
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In the last few months, what in principle seemed to be a temporary slowdown in activity in emerging Europe has become a more significant development. At the beginning of this year, in the five economies we usually analyse in this report, namely Poland, the Czech Republic, Hungary, Slovakia and Romania, the indicator of economic sentiment, which summarizes the cyclical point of economic activity, was at its highest since the crisis of 2008-2009. From this point on, the indicator started to enter a more volatile phase, embarking on a noticeably downward trend from the second quarter of the year and even more clearly in July and August.
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Economic growth figures for the second quarter, recently published, have confirmed the diagnosis suggested by the economic sentiment indicator: emerging Europe is completely immersed in a phase of slowing activity. Given this situation, the immediate question is whether this trend looks like continuing. With the information currently available, the answer is in the affirmative.
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...which, added to the downturn in the euro area, means that its growth forecasts for 2011 and 2012 must be revised downwards.
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Firstly, the indicator's rate of decrease suggests that the decline in the economy is gaining in intensity, so that this process is unlikely to end suddenly. Moreover, if we consider that the main reason underlying the loss in economic dynamism is the economic downturn in the euro area, the main destination for the region's exports, then we must also rule out any fast improvement in this area, as current forecasts point to growth in the euro area over the next few quarters being less than had been expected before the summer. All this points to the need to revise downwards the economic growth forecasts we were applying for emerging Europe.
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Necessarily involved in this downward revision are national factors that, in themselves, lie behind the current cyclical situation of the five economies in question. Given its economic weight and recent good performance, it is appropriate to begin our analysis with Poland. Unlike its neighbours, Poland is still benefitting from a more dynamic domestic demand, a trait that gives it more leeway to withstand weakening exports. This explains, for example, why its economic growth remained unchanged in the second quarter. We believe this inertia will continue for some time and that it won't be until 2012 that the slowdown in activity will make its presence fully felt. A certain adjustment in fiscal policy will also contribute to this lower growth, very necessary after years of relaxation in this area. In short, we expect Poland to grow by 4.0% in 2011 and afterwards by 3.3% in 2012.
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This revision is little in the case of Poland, protected by a resistant domestic demand.
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The Czech Republic and Slovakia, however, are already suffering from a decline in their exports. For both countries we have notably revised downwards our growth forecasts for 2011 and 2012. In the case of the Czech economy, we now expect GDP to remain stuck at a growth rate of just above 2% annually for both years, while in the case of Slovakia this will fluctuate around 3.5% (above, in 2011; below, in 2012). As a reference, it should be noted that, before the summer, we expected the Czech Republic to grow in the region of 3% and Slovakia by 4%.
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In the Czech Republic and Slovakia, the brake on exports has worsened their prospects.
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Nonetheless, the least advantageous economic situation will be the one suffered by Hungary and Romania. These two countries have stumbled upon unfavourable international financial developments just as it seemed that the worst of the fiscal adjustment from years before lay behind them. In the case of Romania, Greece's financial tensions have had a notable effect, as suggested by the rise in country-risk indicators. This is a logical precaution taken by investors as the country's financial links are appreciable (especially through the significant banking presence of Greek banks).
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In the case of Hungary, the punishment being doled out by investors is down to a different reason, namely the loss of credibility suffered by the country's fiscal policy over the last year and a half. This erosion has come from the combination of a communication policy that has sometimes surprised investors, economic policy decisions that are not very propitious for long-term growth (the most recent, a measure that would allow bank credit granted in foreign currencies to be paid off in advance at an exchange rate that would notably penalize financial institutions) and its difficulties in accomplishing the budget control plans announced (more due to negative economic developments than public apathy, it must be said).
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Hungary and Romania are forced to carry out further fiscal adjustment measures, a situation that will hinder their growth in 2012.
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Within this context of certain financial punishment and an economic scenario that is increasingly less propitious, the response of both countries must include reinforcing fiscal orthodoxy by means of restrictive fiscal policy for 2012. This measure is necessary but will hinder the growth expected. Should our scenario come about, Hungary would grow slightly above 1% in 2011, picking up marginally in 2012, while Romania would go from growth scarcely above 1% in 2011 to somewhat above 2% in 2012. In conclusion, emerging Europe seems to have embarked upon a phase of slower growth for the next few quarters. Nonetheless, and to end on a less circumspect note, we should be consoled by the fact that inflation, which had clearly become threatening in the first half of 2011, is now moving away from alarming levels. At least, although the slowdown might strangle the economy, inflation shouldn't suffocate it.
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