Euro Area: Economy ends 2016 on a high note
March 1, 2017
The Eurozone’s slow and steady recovery picked up steam in H2 2016, closing the year on a strong note. A second estimate showed that GDP growth came in at a solid seasonally adjusted 0.4% over the previous quarter in Q4, matching Q3’s reading but exceeding Q2’s 0.3% growth. The Eurozone’s economy demonstrated remarkable resilience to geopolitical uncertainties last year, defying earlier expectations of a slower recovery. GDP expanded a healthy 1.7% for the year as a whole, down only slightly from 2015’s 1.9%. Although a breakdown of components is not available yet for the fourth quarter, the common-currency bloc’s growth story is likely to have remained the same as in the previous quarter with a strong labor market, high economic sentiment and ultra-easy monetary policy acting as tailwinds for the domestic economy.
The positive data release in combination with an ever-cloudier global backdrop has sparked the key question for the Eurozone this year: does the current economic momentum have legs?
Leading indicators for 2017 suggest that a faster recovery is in the cards, at least for Q1. The composite PMI rose to a level not seen in almost six years in February and economic sentiment across the common-currency bloc is high, despite uncertainty related to the political outlook. Moreover, inflation also rose to a multi-year high in January, confirming the healthy economic conditions in the continent, although a rapid increase in inflation in the coming months could take a bite out of consumer spending. Overall, the FocusEconomics panel sees a strong start to the year with GDP growing 0.5% from the previous quarter in Q1.
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Despite the recent firming of activity, a number of obstacles are still plaguing the sustainability of the Eurozone’s recovery. High debt loads in certain economies, banking sector vulnerabilities and a lack of policy coordination are all threatening the economy’s pace of recovery going forward. These obstacles are further complicated by the jam-packed election cycle facing the region this year as changing leaders confound the bloc’s policy agenda.
Brighter prospects for 2017
The FocusEconomics panel upgraded its outlook for the Eurozone this month as incoming data on the bloc points to firmer momentum. The FocusEconomics panel sees the Eurozone economy growing 1.6% in 2017, which is up 0.1 percentage points from last month’s forecast. An improving labor market and ultra-easy monetary policy should support the domestic economy this year, while the external sector benefits from a pick-up in global growth. However, rising inflation will take some wind out of consumption and growth will come in below 2016’s 1.7%. For 2018, the panel sees GDP expanding 1.5%.
Looking at the individual countries in the region, nine economies saw brighter prospects as the recovery picks up pace, including Italy, the Netherlands and Spain. No change was made to the projections for the remaining economies, with the exception of Ireland whose forecast was downgraded.
Luxembourg, Ireland, Malta and Slovakia are expected to be the fastest-growing economies in the region this year, all expanding above 3.0%. On the other side of the spectrum, Finland and Italy will be the region’s laggards, growing at 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 the rest by growing 2.5%. Germany is seen expanding 1.5%, followed by France at 1.3%.
GERMANY | Growth rises to multi-year high in 2016
The German economy ended the year on a moderately positive note. GDP growth accelerated on the back of stronger private and government consumption, the former thanks to the continued strength in the labor market and the latter as a result of refugee-related spending. Fixed investment also contributed strongly to growth, swinging back to expansionary territory owing to the boom in housing construction. Q4’s result brought full-year GDP growth to a multi-year high in 2016. Economic momentum seems to have recovered in February following a series of disappointing data in January. Business confidence and the PMI reached multi-year highs in February, after having moderated slightly in January. Moreover, in February, consumer confidence remained high, supported by the lowest unemployment rate since reunification. Adding to the positive storyline, the German public sector achieved a record fiscal surplus of EUR 24 billion in 2016, despite the high added cost of the refugee crisis.
GDP growth will be supported by strong, albeit slowing, domestic demand growth. In particular, private consumption will benefit from continued labor market tightness and strong wage growth. The external sector should provide a positive contribution to growth as well. However, heightened global uncertainty poses the main downside risk to growth. Our panel expects GDP to grow 1.5% in 2017, which is unchanged from last month’s forecast. For 2018, the panel expects GDP growth of 1.6%.
FRANCE | Corruption scandal opens up election race
Preliminary data show that the French economy shifted into higher gear in the fourth quarter thanks to a strong performance of the external sector and the domestic economy. The quarterly print, however, failed to provide much impetus to the economy as annual growth decelerated in 2016 from 2015’s already weak reading. The deceleration underscores what was a difficult year for France as massive strikes, a challenging external scenario and the impact of terrorist attacks in the country dented growth. The latest data, however, are positive and suggest that the positive momentum from Q4 carried into this year. On the political scene, the first round of the electoral race has become more open since front-runner François Fillon was rocked by a corruption scandal. The center-right candidate is now neck-and-neck with independent Emmanuel Macron for a ticket to face far-right Marine Le Pen in the second round.
ITALY | Economy remains stuck in a low gear
The latest indicators for Italy’s economy paint an unclear picture of how it is faring at the start of 2017. Consumer confidence was less upbeat in February, likely restrained by rising inflation and elevated unemployment. However, in the same month business sentiment improved and in January the Manufacturing PMI, despite declining slightly, stayed in positive territory, supported by growing production and new orders. It’s likely that companies are also benefiting from both the reduction in the corporate income tax rate and the introduction of a flat tax on small firms’ income included in the 2017 budget. The mixed bag of economic signals at the start of this year comes on the back of preliminary estimates which show that the economy lost some steam in the final quarter of 2016. Italy continues to suffer from several structural weaknesses, such as a high tax burden, cumbersome bureaucracy and a dangerously-high public debt, which constrain its potential GDP growth and therefore makes it much more difficult to overcome other fragilities, such as the rehabilitation of its stressed banking system.
Italy’s economy looks set to decelerate slightly this year, restrained by weaker private consumption, which will suffer from higher inflation and subdued wage increases. A reigniting of the death spiral between public debt and banking system instability represents the main downside risks to the outlook. Analysts expect the Italian economy to expand 0.9% in 2017, which is up 0.1 percentage points from last month’s forecast. For 2018, the panel sees growth of 1.0%.
SPAIN | Port workers prepare for strike
Spain’s economy outperformed most of its European peers last year as renewed confidence, an improving labor market and solid export growth kept the recovery in a high gear. Leading data for the first quarter of 2017 show that the economy is on a broadly steady footing: the manufacturing PMI rose to the highest level seen since May 2012, but the services PMI moderated slightly. Meanwhile, trade flows will likely see a slight disruption in March due to the upcoming nine days of strikes by port workers. The strikes, which are set to start 6 March, are in response to a government measure that would end closed-shop hiring. While the bill still has to be passed through parliament, any prolonged labor disruption will likely dampen trade flows as the majority of Spanish shipments pass through its ports.
FocusEconomics panelists upgraded their view of the Spanish economy this month and now see GDP growing 2.5% in 2017, up 0.1 percentage points from last month’s forecast. An improving labor market will support the economy’s expansion, however, higher inflation will hurt households’ real income and growth will come in below last year’s robust 3.2%. For 2018, the panel sees growth easing to 2.1%.
INFLATION | Inflation soars to four-year high in January
Harmonized inflation came in at 1.8% in January, above December’s 1.1% and marking the highest reading since February 2013. Higher energy prices have caused inflation to exit what European Central Bank President Mario Draghi has called the “danger zone” of below 1.0%, easing concerns that the euro area was stuck in a deflationary context. Divergent trends in price pressures across countries have ramped up debate over how the ECB should proceed regarding its monetary policy program and some analysts have begun to call for a tapering of the bond buying program.
Many of our analysts raised their inflation projections up a notch this month and the Consensus Forecast now foresee prices growing annually at an average rate of 1.5% this year, after a meagre 0.2% in 2016. The higher print will be driven by the diminished impact of low energy prices and reduced economic slack. In 2018, inflation is seen holding steady at 1.5%.
Written by: Angela Bouzanis, Senior Economist