Euro Area: Surging activity puts spotlight on ECB
July 26, 2017
The Eurozone’s recovery has gone from modest to energetic in recent quarters, highlighted by a robust 0.6% increase in GDP over the previous quarter in Q1 2017. The reading marked the second-highest growth since pre-crisis years and was sustained by a better performance in the external sector along with a sound domestic economy. These tailwinds are likely to have remained in place in Q2 and incoming data is strong. Economic sentiment is at a multi-year high, while conditions in the labor market have improved further. Overall, FocusEconomics analysts project that GDP expanded a healthy 0.5% quarter-on-quarter in Q2.
The positive data is accompanied by a more stable political environment to boot. France’s government unveiled its reform agenda, which focuses on rekindling finances and boosting growth, as politics are finally in the rearview mirror following a long election cycle. Greece is moving closer to financial independence after returning to financial markets and following the EU Commission’s recommendation for the Union to end the country’s Excessive Deficit Program. In addition, the IMF is finally supporting the country’s third bailout program and offering a conditional USD 1.8 billion loan to the indebted nation. While some uncertainties still remain—most significantly a looming election in Italy, lack of government in the Netherlands and separatist movement in Spain—risks are largely contained for the time being and euroskepticism appears on the wane.
The solid activity and reduced risks have caused all eyes to turn to the ECB’s ultra-loose monetary policy stance. A number of analysts are speculating that tapering the bond-buying program will be on the Bank’s H2 agenda as a scarcity of assets is plaguing the program. However, despite roaring activity, inflationary pressures are still low in the bloc due to moderate wage growth and receding oil prices, complicating the Bank’s next move. While H1 2017 was all about politics, it looks as though the ECB’s next move will play heavily in the Eurozone’s economic discourse in H2.
Head on over to our Euro Area page for more recent economic news on the region.
Growth forecast upgraded for second consecutive month
The FocusEconomics panel raised its outlook for the Eurozone this month, lifting the 2017 GDP forecast by 0.1 percentage points from last month’s Consensus Forecast report. Strong data and diminished risks are supporting the common-currency bloc’s upgrade and GDP is seen growing a robust 1.9%, thanks to a strengthening labor market, improved external backdrop and reviving investment. Next year, growth is seen slightly more modest at 1.7%.
The region’s upgraded outlook was mirrored by a number of upward revisions for individual economies. 12 countries saw their GDP forecasts lifted, including France, Greece, Italy and Spain. All remaining economies saw no change to their GDP forecasts.
Ireland and Malta are expected to be the fastest-growing economies in the region this year, expanding at rates of 4.0% or above. On the other side of the spectrum, Greece and Italy will be the region’s laggards, both growing at around 1.0%. Among the remaining major economies in the region, Spain will outperform the rest with 3.0% growth. Germany is seen expanding 1.8%, followed by France at 1.5%.
GERMANY | CDU takes commanding lead in the polls
The mood remains bright in Germany as both hard and soft data point to continued improvement in the already-healthy economic momentum. Industrial production, retail sales and exports grew strongly in May, suggesting that tightening labor market conditions and the global cyclical upswing are having a tangible, positive impact on the German economy. The positive dynamics are also expected to continue through the summer: consumer and business confidence have been hovering at, or close to, all-time highs, in part thanks to receding political uncertainty following the French elections in May and June. The upbeat narrative seems to be having a knock-on effect on the political front, too, just two months out from the parliamentary election. Angela Merkel’s ruling Christian Democratic Union party is back to polling at close to its 2013 election result, when it just missed out on an absolute majority.
A tight labor market, which is expected to push up wage demands, receding political uncertainty at home and across Europe as well as healthy external demand should ensure GDP growth will remain robust this year. Our panel expects GDP to grow 1.8% in 2017, which is unchanged from last month’s forecast. For 2018, the panel expects GDP growth of 1.7%.
FRANCE | Macron gets to work, unveils reform agenda
The first details of president Macron’s reform agenda were unveiled in early July showing how the government plans to strike a balance between healing public finances and rekindling growth. The reform schedule has been laid out with the government planning to address the critical labor reform this fall followed by vocational training and pensions. The government plans to cut spending by 3% of GDP and increase taxation by 1% to reduce the elevated public debt burdenand ensure the fiscal deficit remains below 3.0%. The government is hoping to act swiftly to take advantage of his high approval rating and prevent detractors, particularly labor unions, from forming a strong opposition. While both camps are gearing up for a confrontation this fall, the latest stream of data is positive and points to steady growth in the second quzarter supported in part by elevated survey-based data.
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 economic future and political trajectory and generated optimism. Panelists participating in the FocusEconomics Consensus Forecast expect GDP to accelerate mildly to 1.5% this year, which is up 0.1 percentage points from last month’s forecast. For 2018, the panel foresees growth of 1.6%.
ITALY | Housing market weakness and banking system spark concerns
The economy seemingly remained in decent shape in Q2, after Q1’s unexpectedly-robust GDP reading. Retail sales continued to expand at a reasonable pace in May, despite a small increase in unemployment, suggesting that growth in household spending carried over into Q2. The external sector also seems to be offering some support to growth: after a slight decline in April, exports jumped in May, mainly on the back of rising demand from other European Union countries and surging orders from China and Russia. Rising domestic and external demand drove industrial output up robustly in May and is supporting both business confidence and the performance of the manufacturing sector. On the downside, the housing market is still showing some weakness and the health of the banking system, despite the latest multi-billion euro state intervention in late June, is far from assured. The government has limited room for maneuver due to the high stock of public debt, and data for Q1’s fiscal deficit shows that, despite some improvement, the road to fiscal consolidation is still long.
The economy is expected to gain some steam this year, but its performance will remain lackluster overall. Growth should come on the back of an improved external environment, steady household spending and rising business investment, which will benefit from tight financing conditions, better demand prospects and tax incentives. FocusEconomics Consensus panelists forecast a 1.2% expansion in 2017, up 0.1 percentage points from last month, and 1.0% in 2018.
SPAIN | Activity remains resilient in Q2, dispelling fears it would run out of steam
The economy seems to have rounded off another quarter of strong growth in Q2. Household spending likely benefited from strong employment growth through the quarter, with Social Security affiliations logging another month of strong job creation in June and employment growth in the manufacturing sector only easing slightly in June from May’s 19-year high. Similarly, industrial output expanded at the fastest pace in nine months in May and the Composite PMI reached a near two-year high in June. The external sector fared equally well, with exports recording strong growth rates despite the slowdown of activity in the UK and labor disputes among Spanish dockworkers. The continued improvement in the external sector was partially the result of double-digit growth in tourist arrivals through May.
Leading data has repeatedly surprised on the upside, dispelling fears of an abrupt deceleration in economic growth and underscoring the economy’s resilience. A healthy domestic sector and a solid performance in exports will continue to buttress growth, which is however expected to decelerate towards year-end as several of the tailwinds that supported growth dissipate. Our panel of forecasters expects growth of 3.0% this year, which is up 0.1 percentage points from last month’s projection. Panelists see growth of 2.4% in 2018.
INFLATION | Inflation eases in June
Complete data confirmed that harmonized inflation fell to 1.3% in June, after coming in at 1.4% in May. Price pressures in the block remain low overall and the ECB kept its ultra-accommodative monetary policy unchanged at its 20 July meeting.
The FocusEconomics panel sees inflation of 1.6% this year, unchanged from last month’s forecast. An inflation figure of 1.6% in 2017 would represent the highest reading in five years. In 2018, inflation is seen averaging 1.5%.
Written by: Angela Bouzanis, Senior Economist