Research Dept. News
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Monthly Report, num 358 - June 2012
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European union - Euro area
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The Euro area: remaining in a zone of turmoil
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The new European mantra is austerity with growth.
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Two political events, due to the elections in France and Greece, will have important economic repercussions over the coming months. Firstly, the recently invested president of France, François Hollande, met with the German chancellor, Angela Merkel, to agree the new European mantra: austerity with growth. The aim is to curb cuts in order to avoid the risk of economic activity contracting, which would jeopardise the financial viability of member states.
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For the moment, no specific measure has been announced that helps to formalize the new European consensus and move towards solving the crisis that is gripping Europe. However, some members of the European Commission, such as the European Commissioner for Economic and Monetary Affairs and the Euro, Olli Rehn, has shown themselves to be in favour of encouraging public investment in key areas. In this respect, the structural and cohesion funds, together with reinforcement from the European Investment Bank, might serve to implement this policy without violating the fiscal compact.
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Secondly, Greece's elections resulted in a split parliament. Due to their differences on the financial bail-out plan, the Greek parties were incapable of coming to an agreement to form a government and new elections are to be held on 17 June. Given that the polls favour the parties that reject the current bail-out conditions, some European economic specialists have reflected on the possibility of Greece leaving the euro. To date, the official position of the European Union is that the Greek republic will remain in the euro area, although the final decision of whether to leave the single currency will be down to the Greeks themselves.
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Growth in Germany stops the euro area from entering into recession.
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In short, the announcement of the date of the elections has not extinguished the hotspots in the financial markets. Rumours and denials, normal in all confused situations, are also combined with an absence of effective leadership and continue to cause turmoil that is difficult for the European economy to digest.
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Given the political and economic uncertainty, deposits are leaving Greek banks as a precautionary measure, which ultimately increases the fragility of the whole system. At the same time, the doubts of international investors as to whether Greece is the only country that might leave the euro increased the pressure on the rest of the Member states. Moreover, the nationalization of Spain's fourth largest bank created uncertainty regarding the state of the country's financial system and the government's capacity to restructure its bank sector, if necessary. Both circumstances have caused the latest financial turbulences in Europe.
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The evident risk is that, should this uncertainty continue over several months, it might harm economic activity. And the latest figures on gross domestic product (GDP) for the first quarter are not particularly encouraging either. Economic activity remained at a standstill in the first quarter, as GDP had zero quarter-on-quarter growth. The economy therefore avoided going into recession after the 0.3% decrease recorded in the fourth quarter last year. Strong GDP growth in Germany (0.5%) was hindered by zero growth in France (0.0%) and falls in Spain (-0.3%) and Italy (-0.8%). In other words, Germany's strong growth avoided the recession in the euro area. However, a clear slowdown in economic activity can now be seen, as reflected in the year-on-year rate, down 0.7% to 0.0%.
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The weakness of the labour market and political uncertainty do not augur a recovery in consumption.
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From the point of view of demand, March's retail and consumer goods figures reported month-on-month growth of 0.3%. With this rise, the year-on-year rate improved from -2.1% to -0.2%. However, retail sales are the perfect reflection of Europe's economic situation with vast discrepancies between the weakness of the peripheral countries and the strength of the central states. Germany and France posted month-on-month growth of 0.8% and 0.9% respectively, while Spain posted a fall of -0.5% and Portugal -2.2%.
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However, European consumer confidence, standing at -19.9 points in April, remains below its historical average and even worsened compared with the figure for March, namely -19.1 points. There are two factors that are holding back the recovery in household consumption, hindered by the lack of confidence. The first is the weakness of the labour market, posting a further increase in the unemployment rate in the month of March to 10.9% and producing the highest unemployment rate for the last fifteen years.
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Exports continue to contribute to the growth of the euro area.
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The second factor is political uncertainty regarding the outcome of the future Greek elections. Both factors are increasing uncertainty and this is very likely to make households reluctant to consume over the coming months.
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Industrial production in the euro area continues to contract.
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Fiscal austerity plans are stopping public spending from boosting the economic recovery. However, the component of net exports continues to contribute positively to GDP growth. The trade balance figures for March reported a surplus of 4.3 billion euros compared with the previous figure 4 billion. Imports dropped by 1.1% month-on-month while exports shrank by 0.9% month-on-month. By country, of note is the large German trade surplus of 10.5 billion euros.
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From the point of view of supply, the euro area's industrial production fell by 0.3% month-on-month in March, increasing the fall in the annual indicator from -1.5% to -2.2%. In spite of Germany's 1.3% month-on-month rise in industrial production, this was not able to offset the falls in France, -1.8%, and Spain, -0.9%. By subsector, the largest drop was in the energy sector, with a month-on-month decline of 8.5%. Unfortunately, the business confidence figure, which fell again in April, does not indicate any upswing in industrial activity over the coming months.
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Inflation is under control.
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One of the consequences of the lack of activity in Europe can be seen in the lower rise in prices. April's consumer price index increased by 2.6% year-on-year, one tenth of a percentage point lower than the figure for the previous month, as suggested by the preliminary data. For its part, core inflation, excluding the most volatile components of food and energy, remains at 1.6%. The most inflationary items in April were clothing and footwear, energy for transportation and electricity. Inflation is approaching the forecast by the European Central Bank (ECB), which estimates that it will end up close to 2.3% by the end of the year. However, the fall in oil prices, started in April and speeding up in May, might be partially offset by the euro's depreciation due to the latest turmoil. Nonetheless, inflation will continue to fall over the next few months.
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In short, the lack of resolution for the Greek situation and its impact on the financial markets continues to grip economic agents and is leading to consumption and investment decisions being put off. Last year, vacillation in the euro area's political management proved to be the economy's worst enemy. In terms of the future economic trend, it is important to avoid a repeat of the hesitation in taking decisions and to commit to definitive solutions for a financial crisis that has already gone on for five years, since its beginnings in the summer of 2007.
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