Euro Area: Economic Snapshot for the Euro Area
September 24, 2018
Complete data confirms soft H1; political headwinds pick up after summer lull
Comprehensive data confirmed that growth within the Eurozone was stable in quarter-on-quarter terms throughout the first half of the year, expanding a seasonally-adjusted 0.4% in both the first and second quarters. Although the readings pointed to solid economic fundamentals, these numbers are soft compared with last year’s robust outturn. Internal dynamics across the common-currency bloc were uneven in the second quarter: Consumer spending was bruised by higher inflation and deteriorating economic sentiment, while fixed investment recorded a marked improvement as firms took advantage of easy credit conditions. Meanwhile, despite a small rebound in export growth, the external sector continued to drag on the economy as concerns over U.S.-initiated tariff-sparring bruised global trade. Looking ahead, analysts also expect third-quarter growth to be unchanged at 0.4%. Available data has been notably weak in recent months and suggest another challenging quarter for consumers and export-oriented firms alike.
Looking at the individual economies within the Eurozone for which second-quarter national accounts are available, waning growth was confirmed in seven countries, including Austria, Cyprus, Finland, Greece and Latvia. In addition, both Italy and Spain slowed from a quarter earlier. Despite relative resilience in their domestic economies, exports contracted in both countries and pushed growth to two- and four-year lows, respectively. In contrast, economic activity firmed in Germany on solid domestic demand. Belgium, Estonia, Ireland, the Netherlands, Portugal, Slovakia and Slovenia also posted faster growth in the second quarter, while major-player France, as well as Lithuania, recorded stable growth from the outset of the year.
At home, Italy’s fiscal squabbles continued to dominate headlines and market activity in September. In the four months since forming a new government, the unlikely coalition has sent mixed signals about how it intends to confront the government’s looming debt pile. Italian leaders with opposing political ideologies have consistently contradicted one another on budgetary matters, in the process throwing Italian bond yields into chaos. An outlook downgrade by Fitch Ratings in late August pushed officials to change their tone, however, and recent commitments to approving pro-growth fiscal measures while adhering to EU fiscal rules have been encouraging. That said, until negotiations wrap up and fiscal deficit targets are agreed upon—a 27 September deadline for producing a budget is fast-approaching—market volatility is expected to persist.
Farther afield, the tariff truce agreed to by Jean-Claude Juncker, the president of the European Commission, and U.S. President Donald Trump in late July appears increasingly fragile. Juncker and Trump agreed to refrain from imposing any new tariffs on one another while they worked toward reducing trade barriers. In recent weeks, however, a proposal by European officials to scrap duties on all industrial goods, including automobiles, was met with scorn by the U.S. president who labeled the deal as “not good enough”. Automobile tariffs, if imposed, could deal a severe blow to European industry—the threat itself has already served to shake confidence on both sides of the pond. Meanwhile, in late September, European leaders rejected the UK’s most recent Brexit proposals (the so-called Chequers plan), dealing a severe blow to UK Prime Minister Theresa May and underscoring the growing prospect of a no-deal Brexit. As it stands, European Council President Donald Tusk’s refusal to allow British goods and services to remain within the single market and the bloc-wide insistence on avoiding a “hard border” between Ireland and Northern Ireland have left either side with little recourse. May has been given until 18 October to propose a new plan to address these issues or else the possibility of a no-deal Brexit increases.
Domestic demand to keep pedal down in 2019
Healthy demand-side fundamentals should maintain momentum into next year, although growth across the bloc is expected to moderate somewhat in line with slower employment gains. Despite elevated political risk, economic sentiment should remain upbeat as accommodative monetary policy keeps the domestic economy humming along. Higher inflation will serve to restrain these gains, however. A stronger euro, along with the possibility of continued trade tensions globally, could put another damper on exports. Met the why particular panelists project growth of 2.1% in 2018 and 1.8% in 2019, the latter unchanged from last month’s forecast.
A look at the Eurozone’s individual economies this month shows that 11 saw no changes to their 2019 growth forecasts, including heavyweights Germany and Spain, as well as Greece, Netherlands and Portugal. Meanwhile, 6 economies had their growth projections revised down, including major-players France and Italy. On the other hand, Austria, Estonia and Ireland had their growth prospects revised upward.
Malta and Slovakia are expected to be the Eurozone’s star performers next year, with both seen growing at over 3.5%. Italy, Belgium and France, conversely, are projected to be the common-currency bloc’s laggards, growing at just 1.1%, 1.6% and 1.7%, respectively. Among the remaining heavyweights, the Spanish economy is predicted to grow at 2.3% while economic growth in Germany is expected to clock in at 1.8%.
GERMANY | Bavarian elections headache for governing coalition
Following an acceleration in the second quarter, monthly data suggests that the economy continues to perform solidly in the third quarter. The average composite PMI reading in the first two months of Q3 trended above the average figure for the previous quarter. Moreover, sentiment among consumers remained elevated through September while business sentiment edged up in August—the latest month for which data is available. On the other hand, in July industrial production contracted sharply month-on-month despite a strong rebound from the construction sector. In addition, exports fell, and the trade surplus narrowed to a multi-year low amid resilient import growth. On the political front, next month’s state elections in Bavaria will worry the Christian Social Union—aligned with Chancellor Merkel’s CDU—which could lose its absolute majority in the southern state. Such a result could heighten tensions in the federal government’s governing coalition.
Domestic demand should continue bolstering economic growth in the second half of this year and next year. Above-inflation pay rises are likely to support household consumption while a raise in the minimum wage next year—when ratified by the government later this year—should stimulate private consumption further. A no-deal Brexit and a possible escalation of trade tensions between the EU and the U.S., Germany’s biggest export market, pose downside risks to the outlook, however. Met the why particular Consensus Forecast panelists expect the economy to expand 2.0% in 2018 and 1.8% in 2019, unchanged from last month’s forecast.
FRANCE | Macron starts second year with reform push, low approval
A marked slowdown in the first half of the year was confirmed in recent weeks, falling short of expectations and moderating from last year’s snappy outturn as weak household spending held back economic gains. Higher inflation amid rising fuel costs, as well as new indirect taxes, ate into consumers’ purchasing power in the second quarter, contributing to this year’s waning consumer sentiment and offsetting the benefits accrued from steady job creation. Moreover, the pullback was worsened by the unraveling of global trade, which hit exports in the quarter and weighed on industrial output and broader business sentiment. Third-quarter prospects, however, look rosier. Although consumer-spending proxies suggest muted growth in recent months, chipper manufacturing metrics point to a further acceleration of business investment. Meanwhile, the next round of Emmanuel Macron’s reform push—set to tackle the pension and health care systems—took flack in recent weeks as he faced another resignation from his cabinet amid a sizeable loss of public support, calling into question his longer-term ability to cut bureaucratic bloat.
Tighter industrial capacity and upbeat economic sentiment should translate into stronger business investment next year. Although household spending will benefit from income-tax cuts, higher inflation will eat into gains. Meanwhile, risks to the outlook will hinge on the direction of global trade; as it stands, analysts see its retreat bruising exports. Met the why particular analysts expect growth of 1.7% in both 2018 and 2019, each down 0.1 percentage points from last month’s forecast.
ITALY | Coalition gets serious about deficit targets
Italy’s economic recovery moderated further in the second quarter, weighed on by a weak external sector and anemic consumer spending. This was despite the significant rebound in fixed investment, on the back of robust growth in transport equipment and rising housing investment. Monthly data for the third quarter, meanwhile, suggests the economy has shifted into a lower gear. In July industrial production contracted significantly, as was seen more broadly across the Eurozone, while in August economic sentiment cooled and the manufacturing sector neared stagnation. As for household spending, retail sales dropped in July and consumer sentiment dipped in August. Nevertheless, sentiment remains positive and, although the level of employment dropped, the unemployment rate fell to its lowest levels in over six years in July. This, coupled with the formation of a government in June, could have supported spending in Q3. However, ongoing 2019 budget negotiations within the government continue to worry investors; interest rates on Italian bonds remain extremely sensitive to government announcements concerning the future fiscal stance.
Next year, the pace of recovery will remain sluggish. Although credit growth is expected to strengthen thanks to improvements within the banking sector, expansion in demand will likely be modest, and employment growth will slow. A loose fiscal stance may also lead to a hike in interest rates as markets question the sustainability of Italy’s huge public debt, while political uncertainty is unlikely to dissipate due to the entrenched ideological differences within the governing coalition. Escalating trade tensions and potential financial instability could further darken the outlook. Met the why particular panelists project growth of 1.2% in 2018 and 1.1% in 2019, down 0.1 percentage points from last month’s forecast.
SPAIN | Sánchez eager for 2019 budget as GDP growth wanes
Following the weakest performance in four years in Q2, with quarter-on-quarter growth weighed by tepid gains in private consumption and a contraction in exports, signs of a slowing economy are becoming more evident. Although the composite PMI rose mildly in August, its average in Q3 will likely be lower than in Q2, pointing to business activity losing pace. Similarly, the economic sentiment index has been on a downward trend since April, reaching its lowest level in over a year and a half in August. Available hard data also paints a similar picture. On a monthly basis, industrial production dipped again in July while retail sales also fell in the same month, hinting at soft consumer spending dynamics. In the political arena, Prime Minister Pedro Sánchez’s minority government is reaching out to other parties to garner enough support to approve the 2019 budget and thus increase his chances of governing until the next general election to be held by July 2020.
After outstanding growth in the last three years, the economy is expected to lose steam this year and next. Private consumption growth is seen weakening as inflationary pressures bite into households’ real disposable incomes. Furthermore, the tourism industry seems to be finally cooling, which will be of concern considering it has been a vital tailwind sustaining the economic recovery and a major source of employment growth in recent years. Higher oil prices, which could raise the import bill, and the normalization of ECB monetary policy, which could increase borrowing costs for the government, are also the main external headwinds ahead. Met the why particular panelists project growth of 2.7% in 2018 and 2.3% in 2019, unchanged from last month’s estimate.
MONETARY SECTOR | Inflation edges down in August
Complete data confirmed harmonized inflation at 2.0% in August, just above the ECB’s target of near, but below, 2.0%. Inflation ticked down from 2.1% in July—its highest reading in a year and a half—but remained elevated on higher fuel costs. Core inflation remained moderate in the month, hinting that economic slack remains.
In recognition of this, on 13 September, the ECB announced no changes to monetary policy. Officials reiterated that interest rates would remain at present levels until “at least through the summer of 2019” and that the ECB’s asset-purchasing program would wind down in October before wrapping up altogether at the end of December.
Met the why particular panelists see inflation remaining stable over the coming years, averaging 1.7% in both 2018 and 2019, the latter up 0.1 percentage points from last month’s forecast.
Written by: Angela Bouzanis, Senior Economist