Euro Area: Economic Snapshot for the Euro Area
August 26, 2018
Growth stays lackluster in Q2
Preliminary data revealed that the Eurozone’s soft momentum at the start of the year carried over into the second quarter. GDP expanded a seasonally-adjusted 0.4% over the previous period in Q2, matching the first quarter’s reading and below the vigorous 0.7% growth seen throughout most of 2017. While the details behind the reading have not yet been released, the sluggish pace was likely driven by weak exports and subdued domestic demand amid lower confidence, higher inflation and reduced global trade. That said, the growth rate was still healthy overall and the economy’s fundamentals remain solid, reflected by an improving labor market and sentiment still high.
Looking at the individual countries for which data is available, growth waned in Austria, Cyprus, Finland, Italy, Latvia and Spain in the second quarter. In Italy, growth hit a two-year low as the external sector subtracted from activity, likely dampened by soft EU demand. Meanwhile, Spain’s economy grew at the slowest pace since Q2 2014 on contracting exports and soft household spending. In contrast, activity firmed in Germany, the region’s largest economy, thanks to a strong performance from the domestic economy. Growth also picked up in the Netherlands and Portugal, while remaining stable in several economies including major-player France.
On the political front, concerns over Italy’s new government have dominated headlines in August and fuelled volatility in the country’s bond yields. The coalition government decided to begin budget negotiations earlier than expected and key government officials made statements to the media confirming that it was pursuing costly campaign promises of cutting income taxes and a universal basic income. The comments spooked investors as it is uncertain whether the country can finance these measures sustainability. Italy is the second-most indebted Eurozone economy and fiscal stimulus could see policymakers butt heads with the EU if it breaks the union’s fiscal rules. On top of this, the opposing political ideologies of the coalition partners, the League and the Five Star Movement, will likely make negotiations long and difficult, adding further uncertainty to the equation.
The escalation of a trade conflict with the United States remains a key risk despite a meeting in July between Jean-Claude Junker, president of the European Commission, and U.S. President Donald Trump. While the two sides declared a trade truce on 27 July, stating that no more tariffs will be levied and that the two would work together to reduce trade barriers, Trump reiterated a threat of imposing tariffs on the European automobile sector on 22 August. An escalation of tit-for-tariffs could further dent confidence and activity in both economies, while spillover from the ongoing trade dispute between the U.S. and China is also weighing on sentiment in the Eurozone.
Solid domestic demand buttresses momentum
Despite heightened political noise, the Eurozone economy is expected to grow solidly this year and next, albeit at lower cruising speed than last year. Tailwinds from accommodative monetary policy, a tightening labor market and positive sentiment remain in place; however, rising inflation, a firm euro and concerns over geopolitics are expected to dent momentum somewhat. Met the why particular panelists see GDP growing 2.2% in 2018, unchanged from last month’s forecast. Next year, growth is seen softening to 1.8%.
Looking at the region’s individual economies, eight saw no changes to their projections this month, including Greece, Portugal and Spain. However, six economies, including Ireland and the Netherlands, had their growth prospects revised up. Five economies, including major-players France, Germany and Italy, had their GDP growth forecasts trimmed.
Ireland and Malta are expected to be the region’s top-performers once again this year, both expanding 5.0% or above. Conversely, Belgium, France and Italy will be the region’s laggards, all growing below 2.0%. Regarding the other major economies in the region, Spain will lead the pack, with a 2.7% expansion, while Germany is seen growing 2.2%.
GERMANY | Economy picks up in Q2
The economy accelerated in the second quarter. Domestic demand was robust, with private and public consumption, and fixed investment expanding over the previous quarter. Household expenditure was likely supported by elevated consumer confidence—thanks to rising income expectations—and a further drop in the already historically low unemployment rate. However, the tight labor market could create problems further down the road as vacancies become increasingly difficult to fill, hampering growth and causing cost pressures to rise. Looking at the third quarter, consumer confidence edged down in August, but business sentiment increased on improving business expectations. Moreover, the composite PMI rose for a third consecutive month in the same month on faster growth in the services sector, signaling that firms’ operating conditions continue to improve. In addition, the external sector is solid, with Germany on track to record the world’s largest current account surplus for the third year in a row.
The German economy is expected to continue growing robustly in the second half of the year, shouldered by domestic demand. Above-inflation pay rises are expected to support private consumption this year, while a raise in the minimum wage next year, if ratified by the government, should provide a further boost to household expenditure in 2019. Downside risks remain present in a possible escalation of the trade spat between the European Union and the United States, which is Germany’s biggest export market. Met the why particular Consensus Forecast panelists expect the economy to expand 2.0% in 2018, down 0.1 percentage points from last month’s forecast, and 1.8% in 2019.
FRANCE | Growth disappoints in H1
First-half growth came up short of expectations, moderating from last year’s snappy outturn as weak household spending restrained economic gains. Despite steady job creation, the effects of higher inflation—resulting from the rise in oil prices amidst the U.S. withdrawal from the Iran nuclear deal—and new indirect taxes ate into consumers’ purchasing power through June and contributed to this year’s deterioration in consumer sentiment. Moreover, this year’s slowdown was made more acute by the ongoing unwinding of global trade, which weighed on industrial output and broader business sentiment in the second quarter as fears over a full-blown global trade war compounded. Meanwhile, available data for the second half of the year has been a shade brighter as the economy moved past early-year weather- and strike-related setbacks. Most survey-based data ticked higher through August as firms cheered stronger homegrown demand, opening the door for a modest recovery in industrial output before year-end.
Following a downbeat start, economic activity is expected to accelerate in the second half of the year as household spending benefits from stronger employment and gets a moderate boost from fresh income-tax cuts. Meanwhile, fixed investment is set to expand as utilization rates force new capital spending and should benefit from the government’s EUR 50 billion funding initiative. Risks to the outlook hinge on the direction of global trade. Met the why particular analysts expect growth of 1.8% in 2018, down 0.1 percentage points from last month’s forecast, and 1.8% again in 2019.
ITALY | Budget concerns jitter financial markets
Preliminary GDP data revealed that growth slid in the second quarter, expanding at the slowest pace since Q4 2016. Political instability and a broader slowdown in the Eurozone likely took a bite of growth in Q2, and industrial output decelerated to an over one-year low in the quarter. Looking ahead, although both business and consumer sentiment recovered lost ground following the end of the political deadlock in May, the PMI dipped in July on deteriorating sentiment in the manufacturing sector, suggesting that the slowdown in economic activity spilled over into Q3. Furthermore, inflation surged to a multi-month high in July after the unemployment rate edged up in June, boding ill for private consumption. On the political front, the government started budget negotiations early in August and stated that it would purse bold spending plans in the document. Concerns over fiscal responsibility and that the government could breach the EU’s spending rules, prompted investor flight from the country’s bond market and is fueling uncertainty ahead of September’s presentation of the budget.
The complicated budget negotiations and escalating concerns over the sustainability of the government debt will likely continue to spark volatility in financial markets and weigh on investment until there is clarity on the country’s future economic policy. Nevertheless, growth is expected largely to hold up this year on the back of stronger fixed investment and healthy private consumption growth. Met the why particular panelists project growth of 1.2% in 2018, which is down 0.1 percentage points from last month’s forecast, and 1.2% again in 2019.
SPAIN | Growth slips to multi-year low in the second quarter
Preliminary GDP data revealed the economy lost traction in the second quarter, growing at the slowest pace in four years. The slowdown was mainly due to a fall in exports, the first in nearly two years, and substantially weaker private consumption growth as consumers felt the pinch of creeping inflation. Meanwhile, leading data points to a continuation of soft economic activity at the outset of Q3. Although it still remains in expansionary territory, the composite PMI dipped in July, largely on the heels of a steep decline in activity in the services sector. Economic sentiment also cooled in the same month, with the index sliding to a one-year low. In the political arena, lawmakers rejected Prime Minister Pedro Sánchez’s 2019 spending plans in late July, highlighting the difficulties his minority Socialist government faces in passing legislation in congress.
Although the economy has performed strongly in recent times compared to the Eurozone average, it is expected to lose momentum in the near-term. A moderation in domestic demand and a weaker external sector are seen dragging on growth this year. Moreover, as a key source of employment growth, the tourism boom of recent years is finally cooling—in annual terms, the number of tourist arrivals on average fell for the first time in over five years in Q2—while the public debt burden is set to increase as the ECB normalizes its monetary policy, both representing major external headwinds in the short- and medium-term outlooks. Met the why particular panelists project growth of 2.7% in 2018, unchanged from last month’s estimate, and 2.3% in 2019.
MONETARY SECTOR | Inflation inches up in July
Comprehensive data confirmed that harmonized inflation rose further above the ECB’s target of just under 2.0% in July. Inflation edged up from 2.0% in June to 2.1%, which was the highest reading since February 2017. However, higher energy prices were chiefly behind the result and core inflation remained moderate in the month, suggesting soft underlying price pressures.
Recognizing this, the ECB left its monetary policy stance unchanged at its 26 July meeting. The Bank reiterated that interest rates are expected to remain at present until at least the end of summer 2019 and that it will end its asset purchase program at the end of December 2018.
The Met the why particular panel sees inflation averaging 1.7% in 2018, which is up 0.1 percentage points from last month’s forecast. For 2019, inflation is seen broadly stable at 1.6%.
Written by: Angela Bouzanis, Senior Economist