Euro Area: Political clouds can't rain on economy's parade
February 1, 2017
Recent data suggest that the Eurozone economy ended 2016 on a bright note, despite it being a rollercoaster of a year in terms of political developments. GDP growth picked up to 0.5% in the fourth quarter, after coming in at 0.3% in the previous two quarters. Rising populism, Brexit and terrorist attacks, on top of other political events, have been unable to dent the economy’s momentum and economic sentiment in the bloc remains at a multi-year high.
At the start of 2017, clouds continue to loom over the Eurozone’s outlook but leading data remains strong. The Netherlands, France and Germany—which together account for over half of the Eurozone’s GDP—are all gearing up for general elections, in a context of waning support for the status quo and unreliable election polls. In addition, Italy could see an early election after the resignation of Matteo Renzi last year. Rising populism will likely play into the election debates, and while traditional parties are still expected to assume power, the rise of populism could push these parties to take a more nationalist stance to secure votes.
Head on over to our Euro Area page for more recent economic news on the region.
Changing leaders could complicate an already jam-packed EU policy agenda, which will be dominated by Brexit negotiations. United Kingdom Prime Minister Theresa May has signaled that the country will seek a hard Brexit, forgoing access to the single market for full control over the UK’s borders, and lengthy negotiations over the future of UK and EU relations will likely ensue. Brexit negotiations, combined with election cycles, could push resolution of ongoing issues such as the Greek debt crisis and economic reforms to the wayside.
Despite these clouds, leading indicators have been resilient in January. The composite PMI pointed to healthy economic conditions and economic sentiment in the Euro area rose. Moreover, the depreciated euro is likely fueling export growth, which suffered from subdued volumes of global trade last year. As a result, FocusEconomics sees the Eurozone recording another healthy quarter with 0.4% growth in Q1.
Economic prospects remain encouraging
Growth is seen remaining robust in 2017, although slowing slightly from 2016’s 1.7%. An improving labor market and ultra-easy monetary policy will fuel the domestic economy this year, while the external sector should benefit from a cheaper euro. That said, rising inflation and higher oil prices will take some steam out of consumption as they reduce tailwinds to household incomes. The FocusEconomics panel sees the Eurozone economy growing 1.5% in 2017, which is unchanged from last month’s forecast. For 2018, the panel sees growth steady at 1.5%.
Looking at the individual countries in the region, prospects for the majority of the economies in 2017 were revised up this month, with improved forecasts for France, Germany, Portugal and Spain, among others. However, Estonia, Latvia, Lithuania and Luxembourg had their forecasts downgraded, while no change was made to the projections for five economies.
Growth trends will be divergent within the region this year, with Luxembourg, Ireland and Malta expected to lead the pack. On the flip side, Finland and Italy are seen lagging behind, with growth rates of around 1.0%. Italy’s economy has failed to take off, as it remains bogged down by banking woes and slow reform momentum. Among the remaining major economies in the region, Spain will outperform most of its peers by growing 2.4%, followed by Germany and France, respectively.
GERMANY Candidates take shape for 2017 vote
German economic growth seems to be cooling somewhat at the beginning of the year. The business confidence indicators for January were down, due to increasing uncertainty in the international environment following Donald Trump’s accession to office. The manufacturing PMI provided a silver lining as it reached a multi-year high in January, while the services PMI deteriorated slightly. Looking back to Q4 2016, data suggest a mild improvement on Q3’s disappointing result. Business and consumer confidence improved over the course of the quarter and retail sales and industrial production posted solid results. On the political front, the battle lines are being drawn for this year’s parliamentary elections. Martin Schulz, the former president of the European Parliament, took over as leader of the Social Democratic Party (SPD) on 29 January from the unpopular Vice Chancellor Sigmar Gabriel and will be the party’s candidate for Chancellor at the 24 September elections.
Heightened global uncertainty will weigh on growth this year, stifling Germany’s all-important export sector. Despite decelerating, domestic demand should be the main contributor to growth this year, supported by a tightening labor market and strong wage growth. Our panel expects GDP to grow 1.5% in 2017, which is up 0.1 percentage points from last month’s forecast. For 2018, the panel expects GDP growth of 1.6%.
FRANCE | Elections take center stage
Growth in the final quarter of 2016 likely quickened after Q3’s soft rebound. In November, industrial production expanded following two months of contraction, unemployment dropped for the third month running and exports grew. Leading indicators made solid gains throughout the October-December period and are currently resting at multi-year highs. In the political arena, former education minister Benoît Hamon won the Socialist Party primaries in late January. The outcome marks a shift to the left within the party and a clear rejection of the more market-oriented policies the current president has implemented during his presidency. With all the main candidates defined unless the centrist François Bayrou also ends up joining the race, all eyes are now on the spring presidential elections, the outcome of which will have vast implications for the economy.
ITALY | Government helps troubled bank
After the slight acceleration in Q3, monthly indicators in Q4 sent mixed signals for the economy. While the PMI remained in expansionary territory throughout the period, business sentiment deteriorated in both November and December and unemployment increased in November, partially neutralizing the gains seen since mid-2016. Moreover, the Italian banking system continues to be an inexhaustible source of financial instability. In late December, the ECB asked Monte dei Paschi to widen the size of its capital increase, to which the Italian government reacted by approving a EUR 20 billion fund to safeguard the banking sector’s stability, therefore raising the amount of public money allocated to rescue the troubled lender. On 13 January, the Canadian rating agency DBRS, the only major agency still giving Italy an A rating, cut the rating to BBB, due to the country’s financial weakness and subdued growth. This will translate into higher borrowing costs for those banks which use Italian debt securities as collateral to receive funds from the ECB.
This year GDP growth will likely weaken, as private consumption decelerates and growth in fixed investment is held back by subdued domestic demand and tighter financing conditions. The probable standstill in pro-market reforms and the potential financial instability stemming both from Italy’s high public debt and from its distressed banking sector represent the main downside risks to the outlook. Analysts expect the Italian economy to expand 0.8% in 2017, which is unchanged from last month’s forecast. For 2018, the panel sees growth of 1.0%..
SPAIN | Budget passes European Commission test
Spain retained its economic momentum in the final quarter of last year, managing to grow 0.7% quarter-on-quarter according to a preliminary estimate. The reading, which matched the expansion observed in the third quarter, was likely driven by still solid household consumption and a stronger contribution from the external sector. An acceleration in industrial production in November and upbeat manufacturing conditions in December both confirm the strength of the Spanish economy at year-end. Government consumption has also provided strong support to economic growth, despite the need to rein in a high fiscal deficit and a sizeable level of public debt. The Spanish government has already presented an amended budget to address the projected fiscal shortfall this year. On 19 January, its proposed measures to reduce the deficit were deemed sufficient by the European Commission to meet the country’s target of a fiscal deficit of 3.1% of GDP in 2017.
Although the economy will still expand at a respectable pace, all engines of growth are set to decelerate this year. Household spending will moderate as the pace of job creation slows, wage growth remains muted and inflationary pressures mount. In addition, public spending will be capped as the government attempts to curb the fiscal deficit. Our panelists expect the economy to grow 2.4% in 2017, which is up 0.1 percentage points from last month’s estimate. For 2018, the panel sees growth easing to 2.1%.
INFLATION | Inflation hits over three-year high in December
Harmonized inflation came in at 1.1% in December, which was above November’s 0.6% and marked the highest reading since August 2013. Inflation climbed in December as the effect of low energy prices dissipated and a weaker euro fueled price pressures. As a result, inflation is now out of what European Central Bank President Mario Draghi has called the “danger zone” of below 1.0%. Despite the rise in prices, the ECB made no changes to its monetary policy at its January meeting. Draghi stressed that a high degree of accommodation was still needed and that the ECB will evaluate price pressures on an aggregate level going forward, ignoring quicker inflation in certain core countries.
Inflation averaged 0.2% in 2016 and is seen picking up to 1.4% this year, which is up 0.1 percentage points from last month’s forecast. The higher print will be driven by the diminished impact of low energy prices, while economic slack will continue to limit higher inflation. In 2018, inflation is seen rising to 1.5%.
Written by: Angela Bouzanis, Senior Economist