Eurozone recovery gains steam in Q1
June 1, 2016
More complete data show that despite heightened uncertainty at the start of the year, the Eurozone’s recovery remains firmly on track. The bloc grew a seasonally-adjusted 0.5% in Q1 over the previous quarter, which was slightly below the 0.6% reported in the new, more timely, preliminary estimate. While the figure was influenced partly by transitory factors, such as the early timing of Easter, the result still marks a strong start to the year for the Eurozone and is an acceleration from Q4’s 0.3% increase. Moreover, the bloc’s economy has shown resilience despite a number of external headwinds including the slowdown in emerging markets and financial market volatility at the start the year. Although a breakdown by components is not yet available, high-frequency data suggest that this resilience is being driven by firming domestic demand.
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Regarding the individual countries in the bloc, growth picked up pace in France and Germany. In France, an improving labor market and easy financing conditions supported the domestic economy, offsetting a weak external sector. Growth hit a two-year high in Germany—the Eurozone’s largest economy—amid booming construction activity and solid private consumption. In addition, growth remained robust in Spain, the region’s top performer this quarter. On the flip side, Greece returned to contraction as austerity measures and political turmoil continued to hamper the economy. Meanwhile, Italy continues to underperform compared to other major European economies, although growth did inch up slightly in Q1.
Many of the conditions that drove the Eurozone’s recovery in the previous quarters remain in place and our panelists expect the economy to expand at a broadly-steady pace of 0.4% quarter-on-quarter in Q2. However, the effects of a number of tailwinds that have been driving the recovery will likely dissipate going forward—mainly the benefits from low oil prices and the depreciated euro. That said, the improving economy, along with a shift in attitudes in the face of an austerity-weary public in many nations, should support a less-tight fiscal policy ahead. In particular, austerity-weary voters are exerting political pressure in many countries and this has led governments to clash with the European Commission (EC) over deficit targets. Against this backdrop, in May, the EC decided to grant Italy additional budget flexibility for 2016 after months of negotiations and delayed a decision on financial sanctions for Spain and Portugal. Spain and Portugal are facing fines for breaking European rules, yet the Commission decided to delay the decision as Spain faces repeat elections in June and in order to give some additional time for Portugal’s new government to repair the country’s finances. On top of the attitude shift regarding austerity, the migrant crisis and increased security spending will also likely contribute to increased government spending in the bloc this year.
Meanwhile, political risks continue to take center stage in the Eurozone. The United Kingdom’s upcoming vote on whether to remain in the EU on 23 June is casting a shadow on the zone’s prospects. Although polls point to a vote to remain in the EU, the split is tight and many voters are still undecided. A country leaving the EU is unchartered territory with huge uncertainties in terms of economic consequences. Moreover, the vote could have ripple effects across the bloc and fuel Euroscepticism, which is already prevalent in many nations. In Austria, Alexander Van der Bellen’s thin presidential election victory on 22 May narrowly prevented the election of a far-right head of state. On a positive note, Eurozone leaders made progress on the Greek crisis in May, unlocking EUR 10.3 billion in funds for the country. The aid will allow Greece to repay its debts in the coming months and avoid a repeat of last summer’s ‘Grexit’ saga, at least in the near term.
Steady domestic demand to fuel growth in 2016
The positive result for the first quarter suggests that the Eurozone’s recovery remains firmly on track. Improving domestic demand should continue to fuel steady gains in the coming quarters, despite concerns over the global economy. The FocusEconomics panel held their 2016 GDP forecast unchanged from last month and see the Eurozone growing at last year’s pace of 1.5% this year amid an improving labor market, ultra-loose monetary policy and less-tight fiscal policy. Looking forward to 2017, growth is expected to inch up to 1.6%.
Regarding the economies in the Eurozone, analysts left their 2016 GDP projections unchanged for 11 of the 19 countries in the region, including France and Italy. Meanwhile, analysts’ forecasts were more positive for five countries, including major players Germany and Spain. The panel revised downward the forecasts for Latvia, Lithuania and Luxembourg.
GERMANY | Growth hits two-year high in Q1
Europe’s largest economy started the year on a high note, with quarterly GDP growing at the fastest pace in two years. The upturn was fueled by strong fixed investment and steady private consumption. The former was buttressed by booming construction activity and the latter benefitted from a buoyant labor market, the ECB’s monetary stimulus and low oil prices. Conversely, the external sector remained a weak spot. More recent indicators suggest that growth dynamics remained intact in Q2. In May, the composite PMI continued to point to expansionary business conditions and businesses became more confident. On top of this, the forward-looking consumer sentiment index hit a nine-month high for June. Meanwhile, the IMF recently recommended several measures for Germany to lift long-term growth. Key recommendations include stepping up public infrastructure spending and accelerating structural reforms to tackle a projected decrease in the labor force.
Healthy domestic demand on the back of favorable monetary and fiscal conditions will offset weak exports and sustain steady growth this year. Following the release of the strong Q1 GDP reading, FocusEconomics Consensus Forecast panelists revised Germany’s economic growth forecast for this year up by 0.1 percentage points to 1.7%. For 2017, panelists expect a 1.6% expansion.
FRANCE | Government enacts controversial labor reform bill
President François Hollande approved in May a controversial labor reform bill by special decree that allows him to bypass Parliament. The bill, which seeks to liberalize the French labor market, is strongly opposed by the country’s trade unions. The government survived two no-confidence motions in Parliament, one of them launched by the president’s own party. However, ongoing protests have intensified and the latest actions have involved blocking oil refineries and shutting down nuclear reactors, thereby limiting the country’s energy supply. Labor unions hope to bring the country to a standstill and force the president to reject the watered-down law. Although the protests have been going on for over two months, economic data remain positive. Quarterly GDP data for Q1 was revised upward, while in May consumer confidence reached an over-nine-year high and the manufacturing PMI improved notably.
The French economy will continue to lag behind other major Euro area countries over the next two years. While the government’s economic reforms promise to support employment and rekindle growth in the medium term, the widening protests against the labor bill are likely to dent economic activity in the short term. FocusEconomics panelists expect the economy to expand 1.3% in 2016, which is unchanged from last month’s forecast. Panelists expect GDP to grow 1.5% in 2017.
ITALY | European Commission grants extra budget flexibility to Italy
The economy grew at a modest pace in Q1, confirming that the country is still on the path of moderate expansion that began at the outset of 2015. The labor market has been improving, partly thanks to government measures, and is expected to continue. After months of negotiations with the European Commission, Italy secured extra budget flexibility in meeting the EU’s deficit reduction targets for 2016. Whether this represents good news for the Italian economy remains to be seen. It gives the government more room to support the economy through fiscal policy, although the delay in reducing the deficit and debt poses additional downside risks to the economic stability of this highly-indebted country.
The ECB’s expansionary monetary policy is contributing to easing financing conditions. The gradual recovery in domestic demand, particularly in investment, will be mildly supportive to growth. However, the slowdown in emerging markets and possible further turbulence in the banking sector pose downside risks to growth. FocusEconomics panelists expect the economy to expand 1.0% in 2016, which is unchanged from last month’s forecast, and see it accelerating to 1.2% in 2017.
SPAIN | Economy continues to grow robustly despite political uncertainties
The political impasse that has characterized Spain for several months seems to have had a limited impact on the economy in Q1. GDP expanded 0.8%, thus matching the previous two quarter’s growth rates. Once again, economic activity was underpinned by a robust performance of domestic demand, with both private consumption and government spending accelerating. Relatively-low levels of unemployment and subdued oil prices fueled household spending. Conversely, the external sector disappointed in Q1 and net trade was a drag on overall growth. Meanwhile, the government’s fiscal position remains worrying. Last year, the country recorded a fiscal deficit of 5.1% of GDP, which was well above the limit of 3.0% of GDP demanded by the European Commission. Consequently, the EC is urging the government to reduce borrowing. A complete review of the country’s fiscal stance has been postponed until after the 26 June general elections.
Looking forward, there are concerns that a continuation of the political stalemate beyond June could negatively impact the economy, in particular investment, and hinder plans to cut one of the Eurozone’s largest fiscal deficits. However, Spain is still expected to grow at one of the fastest rates of the Eurozone. Our panelists expect the economy to grow 2.8% in 2016, which is up 0.1 percentage points from the previous month’s estimate. For 2017, the panel sees growth moderating to 2.3%.
INFLATION | Consumer prices fall in April
Harmonized consumer prices returned to negative territory in April, falling 0.2% on an annual basis. The result followed March’s flat growth and comes despite efforts by the European Central Bank (ECB) to spur inflation. Low energy prices have caused inflation in the Eurozone to linger in what ECB President Mario Draghi called the “danger zone” of below 1.0%.
Inflation is expected to return to the common-currency zone this year, although it will remain meagre overall. Our panel of analysts cut their inflation projections by 0.1 percentage points this month. The Consensus view from our panel of analysts is that inflation in the Eurozone will average 0.2% in 2016. Looking forward, the majority of analysts agree that inflation will rise gradually and average 1.4% in 2017.
Written by: Angela Bouzanis, Senior Economist
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