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The euro area: cautious steps towards stabilization
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Greece and the new growth forecasts in the European Union attract economic and political attention.
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Three significant factors have emerged in the euro area in the last month: the progress being made with the Greek situation, the new growth forecasts by the European Commission and the publication of its first alert mechanism report on macroeconomic imbalances in the European Union (EU).
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On 21 February, after a marathon meeting of more than thirteen hours of intense negotiations, Eurogroup approved Greece's second financial bail-out. Agreement was reached after the Greek parliament passed a package of economic measures
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The Eurogroup approves a second financial bail-out for Greece.
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The agreement is complex and we shall outline its key points here. Firstly, this second bail-out totals 130 billion euros. Secondly, the aim of this new package is to lower the stock of Greek debt from 164.0% of its gross domestic product (GDP) forecast for 2011 to 120.5% in 2020. To achieve this, the interest charged to Greece for bilateral loans will have to be lowered, backdated to 2010. The margin is now 150 basis points, compared with the 200 for the first three years and 300 for subsequent years, reducing the country's net borrowing by 500 million euros.
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Lastly, one of the key pieces in the agreement, which the Eurogroup mentions in its release, is the agreement reached by private creditors and Greece on a voluntary write-down of public debt of 53.5% of the nominal value of Greek bonds. Approval of the bail-out requires Greece's acceptance of greater control in situ by the troika's experts, as well as the creation of a blocked account to prioritize debt payments.
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This agreement, subject to a minimum participation of international creditors in the write-down agreement (whose ultimate outcome is not known at the time of writing), prevents Greece from going bankrupt and halts the serious consequences of a disorderly default for the rest of the euro area. However, the challenge facing Greece is still considerable and the margin for error in implementing these new measures is very small, so volatility in the financial markets is unlikely to lessen over the next few months.
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The European Commission publishes its new growth estimates for member states of the European Union...
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On the other hand, the European Commission has published its update of the macroeconomic forecasts for the euro area. Due to the rapid change in economic conditions and the latest events, the Commission decided to recalculate its estimates for all countries.
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...and the first alert mechanism report on macroeconomic imbalances.
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There are three particularly significant changes in the new forecasts. Firstly, growth has been revised downwards in 2012 for Germany and France, to 0.6% and 0.4% respectively. However, Italy has suffered a sharper revision with a decline forecast of -1.3%. Of note is the sharp downward revision of some peripheral countries due to structural reforms being introduced that reduce growth in the short term but make the economies more flexible in the medium term. This is the case of the forecasts for Portugal and Greece, with drops of 4.4% and 3.3%, respectively.
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Lastly, the European Commission publicized its first alert mechanism report on macroeconomic imbalances. This report forms part of the new macroprudential supervision system approved on 13 December last year in the European Union. The aim is to be able to advise on preventative economic policies before these imbalances jeopardize the stability of any member state and might even create negative externalities for the rest of the European Union's members.
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Ten macroeconomic indicators have been chosen that highlight imbalances in external positions, competitiveness and also the internal imbalances of the different member states. The conclusion of the report selects several countries, including Spain, France and Italy, where a more in-depth analysis needs to be carried out to study whether these imbalances require recommendations from the European Commission for their correction. If the countries don't apply these recommendations, they could incur fines that might be imposed by the Council of Ministers.
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Fourth quarter GDP figures for the euro area show a drop of 0.3% quarter-on-quarter...
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All these events should help to reduce the level of uncertainty that afflicted Europe's economy during 2011. A lack of confidence that has had a negative effect on economic growth. According to flash figures for the fourth quarter on gross domestic product published by Eurostat, this fell by 0.3% compared with the third quarter, while year-on-year growth ended the year at 0.7%.
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...although the latest leading economic indicators point to the decline stabilizing.
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This was the first fall in activity since the second quarter of 2009 and the decline will probably continue in the current quarter due partly to the effect of the adjustment measures being applied by a large number of countries. The euro area would therefore go into recession again. In fact, at the end of 2011 Italy, the Netherlands and Belgium were already in recession, joining Portugal. On a positive note, France grew by 0.2% quarter-on-quarter, more than expected, although this could not entirely offset the 0.2% fall in Germany.
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Developments in resolving the Greek bail-out have coincided with the publication of a series of economic indicators that point to the deterioration in the euro area's economic situation stabilizing. For example, retail sales shrank at the end of the fourth quarter last year but December's figures were slightly better than those posted the previous month, although the year-on-year drop was still 1.3%. On the other hand, consumer confidence, which hit a record low in December of -21.3 points, picked up in January to -20.7 and, in February, consolidated its improvement at -20.2 points.
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The foreign sector is also boosting growth in the euro area as it is partly offsetting the slowdown in domestic demand. In fact, the euro area posted a surplus of 9.7 billion euros in December. Seasonally adjusted, while exports grew by 0.1% month-on-month in December, imports were down by 0.9%.
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From the point of view of supply, industrial production in December continued its decline, widespread in several countries in the euro area. In particular, Germany's industrial production recorded a fall of 2.9% month-on-month. However, this figure should be interpreted in combination with the upward revision of figures for the previous month and the publication of Germany's factory orders for December, up by 1.7% month-on-month. France's industrial production was also negative, down 1.4% month-on-month, leaving the annual growth rate at 0.8%. On the other hand, although Italy posted positive growth of 1.4% month-on-month in December, this was not enough to offset the year-on-year drop of 7.7%. In short, the euro area's industrial production in December recorded a poor -2.2% growth year-on-year.
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Industrial production continues to shrink.
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However, some improvement can be glimpsed in the situation, judging by business sentiment surveys. For example, business confidence for the manufacturing sector has stopped its decline of the last few months. This movement points to a certain stabilization for the euro area's industrial sector in the coming months.
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Nonetheless, the possible improvement has yet to affect the labour market which, being a delayed indicator for the economy, is still seeing job losses. Certainly, the unemployment rate in December in the euro area rose by one tenth of a percentage point to 10.4%, continuing the upward trend started during the second half of last year. The number of unemployed in the euro area in December increased by 20,000 people and is approaching 16.5 million.
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The unemployment rate increases to 10.4%.
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Rising oil prices mean that inflation did not fall in January, according to the leading indicator published by Eurostat which shows a year-on-year increase of 2.7%, repeating the figure published in December. Although sluggish economic activity is more than likely to help push prices back down over the coming months.
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The situation is too fragile to be able to claim with all confidence that the euro area has got over its last bad patch.
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In summary, the approval of Greece's second bail-out, accompanied by economic data that point to the economic situation stabilizing, are good news for the rest of the year. However, this does not make the current economic situation any less serious, even more so taking into account the fact that a further rise in oil prices or a greater lack of confidence, caused by the fragile economic trends in the euro area's peripheral countries, might lead to economic activity going off the rails again.
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