Euro Area Economic Outlook May 2017

Economy charges into Q2

Euro Area: Economy charges into Q2

May 3, 2017

Growth continues to show signs of broadening as the Eurozone’s recovery benefits from strengthening internal and external demand. A firming labor market and a brighter global growth environment are supporting sentiment within the bloc, which came in at a level not seen since 2007 in April. Moreover, other economic indicators continue to record positive readings, highlighted by the composite PMI’s six-year high in April.

Looking at available GDP data for the individual economies, preliminary readings show that growth gained steam in AustriaBelgium and Spain in the first quarter of the year. However, activity lost some momentum in Lithuania and GDP expanded a meagre 0.3% over the previous quarter in the French economy. Economic growth has been lackluster in France and the incoming government will inherit an economy badly in need of reforms to boost growth. Overall, the influx of robust data for the bloc as a whole is supporting our analysts’ expectations of solid growth in the first quarter of 2017 and our panelists see GDP increasing 0.5% from the previous quarter.

Head on over to our Euro Area page for more recent economic news on the region.

The improving economic picture, however, is not at the forefront of Eurozone discourse, as politics takes center stage. Following a wild campaign race, the first round of France’s presidential election ended largely as expected and centrist Emmanuel Macron and right-wing Marine Le Pen will face off in the runoff on 7 May. The vote is unlikely to provide a Brexit or Trump-like shock outcome, as Macron is widely favored to come out on top. Moreover, even if Le Pen managed to become the next president, the parliament—whose make-up will be decided in June—holds control over domestic policy, and either candidate could face difficulty implementing policy without strong legislative backing. 

After France, the common-currency bloc’s largest economy will hold general elections in September, at which the Eurozone’s most iconic leader, Angela Merkel, will seek reelection. However, risks of a shock to the bloc’s politics from Germany’s election are low, as the contest is likely to be a classic battle between the two mainstream parties. Meanwhile, early Italian elections are off the table and a vote is not expected until next year. The shift in timing removes one key political hurdle for the Eurozone this year, although longer-term, the risks associated with the Italian vote are high given the convoluted political landscape. 

2017 prospects are bright

The FocusEconomics panel upgraded its outlook for the Eurozone by 0.1 percentage points this month and sees the economy growing a healthy 1.7% in 2017. The upgrade came on the back of strong incoming data for the common-currency bloc and strong dynamics at home as well as abroad are seen driving this year’s robust growth. However, rising inflation could take a bite out of consumer spending and is a risk to the outlook. For 2018, the panel sees GDP growth broadly steady at 1.6%.

Looking at the individual countries in the region, 14 economies saw better prospects, including France, Ireland and Spain. Three countries had no change to their outlooks, including Germany and ItalyCyprus and Greece were the only countries whose forecasts were downgraded.

Ireland, LuxembourgMalta 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, Greece and Italy will be the region’s laggards, growing at around 1.0%. Among the remaining major economies in the region, Spain will outperform the rest by growing 2.7%. Germany is seen expanding 1.6%, followed by France at 1.4%. 

See the full FocusEconomics Euro Area report

GERMANY | Economy defies mounting global headwinds

The German economy continues to gain steam this year, although official figures are still outstanding. Robust external demand is boosting the all-important external sector, which is positively reverberating across the economy. Moreover, domestic growth is also on the upside, mainly propelled by solid developments in the construction sector and healthy sentiment among German manufacturers. Against this backdrop, business confidence rose to a nearly six-year high in April, defying fears of rising trade protectionist policies and the expected tough Brexit negotiations. Consumer confidence remained at high levels in May, partially reflecting a dynamic job market and the continued decline in the unemployment rate, which fell to a new record low in March. On the political front, the 14 May election in North Rhine-Westphalia will be another test to assess Chancellor Angela Merkel’s popularity ahead of the 24 September federal election.

Economic growth will remain robust this year on the back of a strong external sector and resilient domestic demand. Higher inflation, however, will weigh on household consumption, while uncertainty could dampen investment. Our panel expects GDP to grow 1.6% in 2017, which is up 0.1 percentage points from last month’s forecast. For 2018, the panel also expects GDP growth of 1.6%. 

FRANCE | Macron at the gates of the Élysée

French voters will decide on 7 May between two fundamentally different economic and political models after the centrist Emmanuel Macron and far-right Marine Le Pen clinched a spot to the second round in the highly-contested presidential elections. The outcome of the 23 April vote was greeted favorably by European financial markets, which had been beset by political uncertainty in the run-up to the vote. While there is a strong consensus among pollsters and pundits that Emmanuel Macron should win the 7 May runoff vote, developments that could alter voting or the outcome in the upcoming weeks are not being ruled out. The next president will inherit an economy that is failing to gain traction according to the latest GDP release, despite very positive survey-based data since the end of last year.

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 23 April elections have dissipated some fears about the country’s economic course and panelists participating in the FocusEconomics Consensus Forecast revised their forecast to 1.4% in 2017, which is up 0.1 percentage points from last month’s forecast. For 2018, the panel foresees 1.5% growth. 

ITALY | Mounting banking problems dent the country’s credit rating

The Italian economy continues to send mixed signals, bearing testament to the weakness of the ongoing recovery. Due in part to the country’s uncertain political landscape and associated unclear economic reform plans, private consumption growth remains sluggish, as shown by the latest data on retail sales. Nevertheless, stronger external demand, especially from EU countries, is supporting the Italian manufacturing sector, and led industrial production to rebound in February. On 21 April, Fitch Ratings downgraded Italy’s sovereign debt from BBB+ to BBB, citing a long list of the country’s unsolved economic problems, including its sluggish growth, fragile banking system and poor fiscal position, as well as the mounting political risks ahead of next year’s elections. In April, in an attempt to meet the European Commission’s fiscal demands, the government approved a raft of measures to raise taxes on tobacco and gambling and to reduce tax evasion, as a result of which it expects to lower the budget deficit to 2.1% of GDP this year, down from its previous 2.3% target. Nevertheless, acting on the revenue side alone risks further depressing private consumption, and our deficit projections suggest the government’s target will not be met.

This year the economy should broadly replicate last year’s performance. While the external sector should offer some support to growth, private consumption is expected to weaken on the back of higher inflation, political uncertainty and a weak labor market. Analysts expect the Italian economy to expand 0.9% in 2017, unchanged from last month. For 2018, the panel sees growth of 1.0%.

SPAIN | All eyes on this year’s budget negotiations

Building on an already strong performance throughout 2016, the Spanish economy expanded at a robust rate of 0.8% in Q1. Households likely remained the linchpin of economic growth as a resilient labor market and a pickup in real estate prices contributed to private spending. This spells good news for a domestic economy that has seen the recent pickup in inflation and stagnant wage growth reducing disposable income, which weighed on retail sales in Q1. The country’s exporting sectors, which are benefiting from improved global demand and robust operating conditions, also buttressed growth. Meanwhile, headlines remain focused on the political wrangling surrounding the approval of a 2017 budget. The proposed budget heavily curtails public investment in infrastructure in a bid to bring the deficit down to the EU target of 3.1% of GDP for 2017. However, the draft, which also envisages an ambitious increase in tax collection and a hike in social security contributions, has been met with skepticism by Central Bank officials, who see revenue expectations as too optimistic.

Although the economy will experience a mild slowdown this year, panelists now expect growth of 2.7%—up 0.2 points from last month’s forecast—as recent data showcase the resilience of the Spanish economy. Indeed, higher investment on the heels of upbeat business sentiment and improved dynamics in the external sector will partially make up for a slowdown in household consumption. For 2018, the panel sees growth easing further to 2.2%. 

INFLATION | Inflation meets ECB target in April

Harmonized inflation came in at 1.9% in April, above March’s 1.5% and marking the second highest reading since January 2013. On the back of robust domestic demand and higher energy prices, inflation has returned to the European Central Bank’s target of close to, but below 2.0%. Despite higher inflationary pressures and the stream of positive data, the ECB maintained its forward guidance mostly unchanged at the 27 April monetary policy meeting.

Many of our analysts raised their inflation projections up a notch this month on the back of reduced economic slack and higher commodity prices. As a result, the Consensus Forecast now foresees inflation of 1.7% this year. If inflation projections for 2017 materialize, it will represent the highest reading in five years. In 2018, inflation is seen inching down to 1.5%.

Get the full FocusEconomics Consensus Forecast Euro Area

Written by: Angela Bouzanis, Senior Economist

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