Euro Area: Economic Snapshot for the Euro Area
July 29, 2018
Economic data turns brighter; politics continues to cloud outlook
The Eurozone economy decelerated sharply in the first quarter of the year, ending the spell of robust growth that was seen in 2017. A slower global recovery and strong euro caused exports to plunge in Q1 and GDP growth to slide to a seasonally-adjusted 0.4% over the previous quarter (Q4 2017: +0.7% quarter-on-quarter). While GDP data for the second quarter is still outstanding, monthly economic indicators suggest that the economy remained in a soft patch at the start of the period but stabilized towards June. Industrial production shrank in April and economic sentiment fell throughout the quarter. However, industrial output rebounded solidly in May and the composite PMI recovered some lost ground in June.
All-in-all, FocusEconomics analysts expect that activity picked up slightly in the second quarter from the first quarter’s slump, although growth remained weaker compared to last year’s highs. Tailwinds from a healthy labor market, ultra-accommodative monetary policy and high sentiment are buttressing momentum. However, a stronger euro has taken a bite out of export growth, while rising inflation is likely starting to weigh on household spending. GDP is expected to have grown 0.5% quarter-on-quarter in the second quarter. Looking ahead, the EU’s economic trajectory is likely to remain the same, with healthy, if moderate, growth. GDP is seen again expanding 0.5% in the third quarter.
While the economy’s underlying fundamentals remain solid, the political landscape is uncertain. Tensions with the United States, the Eurozone’s largest trading partner, are high following tit-for-tat tariffs implemented in June. Jean-Claude Junker, the president of the European Commission, will meet U.S. President Donald Trump on 25 July for negotiations to avoid a worsening of the conflict. Trump has threatened to escalate the dispute by levying tariffs on the automobile sector, which would have a more pronounced effect on economic activity than the current duties on steel and aluminum. Reaching a deal will likely be difficult, however, given the anti-trade rhetoric emerging from the United States, and Junker will also have to juggle the preferences of different countries within the EU.
The Eurozone’s relationship with another key ally, the United Kingdom, also remains in flux as Brexit draws closer. The European Union and the UK have still not agreed on a future trading relationship, and the latest white paper unveiled by Prime Minister Theresa May on 12 July contained several measures that European officials are unlikely to agree to. Moreover, political uncertainty is also high within the common currency bloc. While a deal over migration saved the German coalition from collapsing in early June, confidence in the government remains low and tensions could easily reignite going forward.
Healthy growth still expected despite heightened political uncertainty
FocusEconomics panelists held their view of the Eurozone economy steady this month, after downgrading the region’s growth prospects in the previous publication. Solid domestic dynamics thanks to an improving labor market, accommodative monetary policy and high confidence should fuel a solid expansion this year. That said, growth is expected to have shifted to a more moderate pace after hitting a 10-year high in 2017, chiefly due to softer exports and rising inflation. Moreover, rising global protectionism and political turbulence remain key risks to the Eurozone’s outlook. GDP is seen growing 2.2% in 2018 and a softer 1.9% in 2019.
Looking at the individual economies, the bulk saw no changes to their projections this month, including Italy, Portugal and Spain. However, five economies, including major players France and Germany, had their growth prospects cut. Cyprus, Estonia, Greece and Luxembourg were the only economies to see higher GDP growth forecasts.
Ireland and Malta are expected to be the region’s fastest-growing economies this year, both expanding 5.0% or more. Conversely, Belgium, France and Italy will be the slowest-growing economies, all expanding below 2.0%. Regarding the other major economies in the region, Spain will outperform the rest, with a 2.7% expansion, while Germany is seen growing 2.1%.
GERMANY | Merkel survives row with CSU
Data for the second quarter paints a mixed picture. Industrial production rebounded with vigor in May—recording the largest month-on-month expansion since last November—while exports grew in the same month. In addition, consumer confidence remained elevated throughout the second quarter on strong income expectations and willingness to buy. This, combined with historically low unemployment levels during Q2, bodes well for private consumption in the quarter. However, business sentiment continued to drop in June, due to less upbeat business conditions. In addition, the services PMI averaged notably lower in Q2 compared to Q1, despite a rise in June. On the political scene, Chancellor Merkel survived a row with the CSU in early July by reaching a deal over the country’s asylum policy, which will see migrants sent back to the countries where they first applied for asylum. Although this boosts political stability in the short-term, the long-term success of the deal will depend on the government’s ability to reach bilateral deals with other countries, particularly Italy and Greece.
While political tensions at home have seemingly eased, escalating trade tensions with the U.S. could weaken the external sector. Despite this risk, the economy is expected to grow resiliently this year and next, shouldered by domestic demand. Strong above-inflation pay rises should spur private consumption, which should receive a further boost next year with the increase in the minimum wage—if ratified by the government. FocusEconomics Consensus Forecast panelists expect the economy to expand 2.1% in 2018, down 0.1 percentage points from last month’s forecast, and 1.8% in 2019.
FRANCE | Lackluster data rolls in for Q2
The most recent data suggests that the economy expanded modestly in the second quarter of the year. Industrial production contracted for the third consecutive month in May, recording the fourth monthly decline so far this year. The industrial sector has been beset by sluggish external demand due to slower growth in the country’s main trading partners. While the composite PMI pointed to robust growth in the private sector in Q2, the quarterly average came in below Q1’s print and was dragged down by declining new orders in the manufacturing sector. In addition, consumer confidence dropped to a near two-year low in June amid mounting unemployment fears. Consumers are growing more fearful that the economic recovery is running out of steam.
The economy is expected to slow this year and next from 2017’s 10-year high, but growth should remain robust nonetheless. Private consumption will likely benefit from a solid labor market, and fixed investment is set to expand strongly on the back of the government’s EUR 50-billion investment fund. Panelists participating in the FocusEconomics Consensus Forecast expect GDP to grow 1.9% in 2018, which is down 0.1 percentage points from last month’s forecast. For 2019, the panel sees growth of 1.8%.
ITALY | Political instability weighs on Q2 data
Economic activity likely moderated somewhat in the second quarter, as the economy went through a prolonged period of political instability and was also affected by a loss of momentum within the EU. Data for industrial production in both April and May, and the average of PMI readings throughout the quarter are consistent with a slowdown in the industrial sector. Moreover, consumer spending seems to have cooled, as retail sales contracted heavily in April and rebounded only timidly the following month. Labor market dynamics, however, remain positive: In May the unemployment rate fell to the lowest level in nearly six years, and the pace of job creation remained strong. Furthermore, May’s figures show that credit growth is firming up, and both business and consumer confidence rebounded in June after the political stalemate was resolved. In the political arena, the government passed a package of measures in early July that will limit temporary job contracts and penalize companies that move production offshore. The bill could discourage foreign investment and hamper job creation, weakening consumer spending.
Despite contracting in the first quarter, fixed investment is seen expanding this year, supported by a strengthening banking system. Moreover, continued—albeit slowing—job creation should underpin household spending. However, downside risks stem from uncertainties surrounding the government’s stability and its economic program, while the bulky public debt poses financial risks. FocusEconomics panelists project growth of 1.3% in 2018, unchanged from last month’s forecast, and 1.2% in 2019.
SPAIN | Sánchez presents economic plan that is unlikely to be passed
Available data points to waning activity in Q2, following a solid Q1 which saw the economy grow at a swifter pace than the Eurozone average. Industrial production lost momentum in April–May, which, coupled with slightly lower PMI readings in Q2, likely indicates some moderation in growth. Moreover, despite healthy employment growth (as measured by social security affiliations), retail sales posted only marginal gains on average in April–May, pointing to soft private consumption dynamics. In the political arena, the new prime minister, Pedro Sánchez, presented his government’s economic plan to congress on 17 July, proposing to raise taxes on corporations and slow the pace of deficit reduction to increase public spending. Given, however, that his Socialist party only holds about a quarter of seats in parliament, Sánchez will likely struggle to garner enough support to shift economic policy.
Economic growth is expected to lose some steam this year on the heels of weaker domestic demand. The economy also faces mounting external headwinds ahead. The tourism industry finally seems to be cooling after experiencing a boom in recent years. As one of the engines of growth and a major source of job creation, this poses downside risks for continued improvement in the labor market and the broader economy. Furthermore, with one of the highest levels of public debt in the EU, the government faces an increased debt burden as the ECB normalizes its monetary policy and ends its QE program. FocusEconomics panelists project growth of 2.7% in 2018, unchanged from last month’s estimate, and 2.3% in 2019.
MONETARY SECTOR | Inflation rises above ECB target in June
Comprehensive data confirmed that harmonized inflation increased in June, rising above the ECB’s target of just under 2.0%. Inflation rose from 1.9% in May to 2.0% in June, the highest reading since April 2017. Higher oil prices largely drove the result. Despite the headline figure, core inflation remained subdued in the month, suggesting soft underlying price pressures.
The FocusEconomics panel sees inflation averaging 1.6% in 2018, unchanged from last month’s forecast. For 2019, inflation is seen broadly stable at 1.6%.
Written by: Angela Bouzanis, Senior Economist