Euro Area Economic Forecast

Economic Snapshot for the Euro Area

June 28, 2017

Economy is off to the races with healthy Q2 growth on the horizon

The Eurozone economy has emerged as a bright spot in global growth this year, as incoming data outperforms expectations and earlier concerns over politics in the bloc appear to have been overblown. Complete GDP data reveal that the economy expanded 0.6% in Q1 over the previous quarter, a notch above the preliminary estimate and the best result in two years as growth broadens across economies. An improvement in the external sector fueled the uptick, while healthy private consumption confirmed that the domestic economy is sound as it is being supported by improving labor markets, easy financing conditions and looser fiscal policy.     

Data for the second quarter suggests that the economy remains in a path of strong growth. The Composite PMI is pointing to its best quarter in over six years in Q2 and the unemployment rate fell in April. Economic sentiment is sitting near a multi-year high and financial conditions remain extremely accommodative.

On top of this, investment is set for a pick-up as political uncertainty ebbs across the region. In June, the second review of Greece’s latest bailout was finally concluded, unlocking vital funds for the country and preventing the possibility of a summer default. Meanwhile, French President Emmanuel Macron’s party and its coalition partner secured a comfortable majority in the legislative elections, giving Macron a strong mandate to move forward with economic reforms. In addition, support for populism across the bloc is on the decline and Chancellor Angela Merkel’s CDU and CSU is the clear front-runner in early polls for Germany’s upcoming vote. All-in-all, our panelists see the Eurozone recording a firm 0.5% expansion in Q2.

Although political uncertainty is clearly receding, the region is not totally out of the woods yet. In the Netherlands, a government still has yet to be formed after March’s elections, which has brought policymaking to a standstill. Italy is in a convoluted situation now that Parliament has rejected a new electoral law that would have brought about elections sooner. In addition, while Spain’s economy is performing robustly, tensions are rising between the central government and Catalonia, which is planning to hold a referendum on independence in October.      

Prospects brighten as political clouds clear

The FocusEconomics panel raised its outlook for the Eurozone this month, lifting the GDP forecast by 0.1 percentage points from last month’s publication. The strong Q1 GDP print along with healthy monthly data and reduced political risks were largely behind the upgrade. The panel now sees the economy growing a solid 1.8% in 2017 and GDP expanding 1.7% in 2018.

Positive dynamics are becoming more comprehensive across the region and 12 economies saw brighter prospects this month, including some of the region’s laggards such as Finland, Italy and Portugal. Greece and Malta were the only economies to have their outlooks downgraded, while five countries saw no change to their GDP forecasts.

Ireland and Malta are expected to be the fastest-growing economies in the region this year, expanding 4.0% or above. On the other side of the spectrum, Greece and Italy will be the region’s laggards, growing at around 1.0%. Among the remaining major economies in the region, Spain will outperform the rest with 2.9% growth. Germany is seen expanding 1.7%, followed by France at 1.4%. 

See the full FocusEconomics Euro Area report

GERMANY | Economy set to record another quarter of strong growth in Q2

 

Germany’s healthy economic momentum shows no signs of abating after the strong showing in Q1. Leading indicators reached multi-year highs over the course of Q2 and businesses in particular are especially confident. While the PMI index moderated slightly in June, the IFO Institute’s business confidence indicator reached a new all-time high. Both illustrate the strong support improved global economic conditions have offered German businesses. While the external sector continues to fulfill its role as Germany’s traditional engine of growth, domestic demand is also expected to have strengthened in Q2. Sky-high business confidence points to strong investment growth, even if it is expected to moderate somewhat from Q1’s exceptionally-high reading. Private consumption in particular continues to benefit from an ever-tightening labor market and record-high consumer confidence. On the political front, the conservative CDU, the Greens and the liberal FDP have agreed to form what is called a “Jamaica coalition” in Schleswig-Holstein, which could have a strong signaling effect ahead of September’s national elections.

GDP growth should remain robust this year, thanks to a strong external sector and resilient fixed investment. However, higher inflation will weigh on household consumption. Our panel expects GDP to grow 1.8% in 2017, which is up 0.1 percentage points from last month’s forecast. For 2018, the panel expects GDP growth of 1.7%. 

FRANCE | Macron eyes reforms after taking control of parliament

The French electoral season culminated on 18 June with a decisive victory in the legislative elections for Emmanuel Macron who turned the political system on its head after sweeping to power in May. The president’s two-party coalition secured a comfortable majority with 60.6% of the seats in the National Assembly. The former banker and socialist minister now possesses one of the strongest mandates in recent history which will allow him to implement his ambitious reform agenda to rekindle growth in the Eurozone’s second-largest economy. Despite Macron’s strong mandate, the road ahead is uncertain and filled with obstacles. Ambitious reform efforts by the previous administration, such as last year’s labor reform bill, were thwarted by massive street mobilizations. The president faces a tough balancing act between pushing deep-seated reform to foster stronger mid-term growth and avoiding widespread discontent that could dent short-term growth, such as what occurred in 2016.

The economy is expected to accelerate this year and next on the back of a recovery in exports and solid domestic demand. The outcome of the spring elections has dissipated fears about the country’s future political trajectory and panelists participating in the FocusEconomics Consensus Forecast expect GDP growth to accelerate mildly to 1.4% this year, which is unchanged from last month’s forecast. For 2018, the panel foresees growth of 1.5%. %. 
ITALY | Labor market woes hold back growth

Italy’s economic recovery is underway, although the many structural weaknesses continue to restrain growth potential. Revised Q1 GDP data surprised markets on the upside with a 0.4% expansion from the previous quarter thanks to solid private consumption and a robust increase in inventories. The print was double the flash estimate and marked an acceleration from Q4’s 0.3% quarter-on-quarter increase. Good retail sales data in April suggests that household spending continues to firm up, despite stubbornly-high unemployment and slow wage growth. On the downside, industrial production seems to have lost some steam in Q2: growth in industrial output softened in April, and the PMI lost ground in May. Moreover, the banking system remains mired in a hefty stock of NPLs. The government injected EUR 5.2 billion into two failed mid-sized banks on 25 June following the European Commission’s approval. It is also offering additional guarantees of up to EUR 12 billion to fund any further potential losses and has assigned the lenders’ good assets to Italy’s biggest retail bank, Intesa Sanpaolo.

The economy should broadly replicate last year’s lackluster performance this year. Corporate tax reforms are expected to spur business investment, while household spending should continue to grow, although it could be restrained by a weak labor market. Several panelists revised up their forecasts after the second GDP estimate for Q1 was published, and the Consensus forecasts a 1.1% expansion in 2017, up 0.2 percentage points from last month, and 1.0% in 2018. 

SPAIN | Growth remains strong in Q2

The economy remains comfortably on track to record another year of strong growth. Industrial production regained some traction in April following a weak March figure, while the services and manufacturing PMIs posted strong readings in both April and May. Employment in the manufacturing sector grew at a 19-year high in May, a testament to the improving dynamics observed in the labor market. In line with this, growth in Social Security affiliations retained its momentum in May, which points to a sharp reduction in the unemployment rate in Q2. An improving job market will continue to shore up private spending despite a slowdown in real income growth linked to higher inflation. Nonetheless, the panorama is less rosy in the political arena. Having successfully cleared a key hurdle last month after securing enough support in Congress to pass the long-delayed 2017 budget, the Rajoy Administration is now facing the Catalonian government’s plan to hold a new independence referendum on 1 October. The run-up to the referendum will weigh on Spanish bond premiums and risks putting economic policymaking on the backburner.

The solid performance in exports and resilient dynamics in the domestic sector will ensure another year of strong growth. Nonetheless, economic activity will lose some steam towards the year‘s end due to a tighter fiscal stance and a gradual slowdown in consumer spending. Our panel of forecasters expects growth of 2.9% this year, which is up 0.2 percentage points from last month’s projection. Panelists see growth of 2.3% in 2018. 

INFLATION | Inflation eases in May

Complete data confirmed that harmonized inflation fell to 1.4% in May, after coming in at 1.9% in April. While inflation has flirted with the European Central Bank’s (ECB) target of close to but below 2.0% in recent months, underlying price pressures remain weak and core inflation came in at a soft 1.0% in May. As a result, the ECB kept its ultra-accommodative monetary policy unchanged at its 8 June meeting and left its bond-buying program untouched.

The FocusEconomics panel sees inflation of 1.6% this year, unchanged from last month’s forecast. If the inflation projection for 2017 materializes, it will represent the highest reading in five years. In 2018, inflation is seen averaging 1.5%.

Get the full FocusEconomics Consensus Forecast Euro Area

Written by: Angela Bouzanis, Senior Economist

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