Euro Area

Economy continues to roar, while political scene becomes more uncertain

Euro Area: Economy continues to roar, while political scene becomes more uncertain

October 26, 2017

A stream of positive data on the Eurozone economy continues to flow in. Monthly indicators suggest that the common-currency bloc recorded another period of robust growth in the third quarter, after GDP expanded by a seasonally-adjusted 0.7% quarter-on-quarter in Q2. Economic sentiment rose to the highest level in a decade in September, while in August the unemployment rate rested at a multi-year low and industrial production soared. Accordingly, FocusEconomics analysts see the common-currency block having grown a healthy 0.5% over the previous quarter in Q3.


While the economic picture is bright, the political scene has become more turbulent in recent weeks in Spain. A push for Catalan independence has caused regional authorities to clash with the central government, leading to widespread uncertainty over future ties. The situation is in flux, clouding the outlook for Catalonia and Spain as a whole. At this stage, an independent Catalonia still appears unlikely, and a number of our analysts project that a compromise or agreement for more regional autonomy will be reached. However, the political crisis could still have an adverse impact on activity through decreased investment and tourism, although the redirection of tourists and investment flows to other areas of Spain could limit the overall impact on the Spanish economy. For more information on our panelists’ views of the crisis.


Meanwhile, the European Union as a whole is facing a broader challenge to its future vision. French President Emmanuel Macron presented an ambitious vision for the EU on 26 September, calling for a common budget and for the countries to work more closely together on matters of defense and immigration. While meaningful institutional reform in the EU could help reduce asymmetric shocks in the region, it remains to be seen if there is an appetite for big changes among the member states. Macron’s vision is not shared by all EU countries, and recent political developments have likely eroded support further. German Chancellor Angela Merkel’s loss of support in the September elections and the new makeup of the German government could put the brakes on her backing greater integration, while Austria’s turn to the right in the October elections is also likely to lead to resistance on fiscal integration. Meanwhile, Brexit negotiations have yielded little progress so far, leaving a lot of uncertainty surrounding the EU’s relationship with the United Kingdom in 2019


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


Prospects brighten despite political jitters


The Eurozone is seen growing a buoyant 2.1% this year on the back of a healthier labor market, ultra-accommodative monetary policy and stronger global backdrop. Next year, activity is expected to decline somewhat, but still remain healthy, as tailwinds to growth


The Eurozone’s 2018 economic outlook was upgraded this month as recent data suggests that the recovery is strong, despite a number of political risks. GDP is seen growing a buoyant 2.1% this year, thanks to a healthier labor market, ultra-accommodative monetary policy and a stronger global backdrop. In 2018, a number of these tailwinds will continue to drive robust growth, although their effects will fade somewhat. GDP is seen growing a resilient 1.9%, which is up a notch from last month’s forecast. In 2019, economic growth is seen expanding to 1.6%.


A number of the economies in the Euro area saw better 2018 prospects this month, with 12 countries having their GDP forecasts upgraded, including France, Germany and Italy. Estonia was the only economy to have its outlook downgraded, while the rest of the countries in the region—including major player Spain—saw no changes to their forecasts.


Latvia, Luxembourg and Slovakia are expected to be the fastest-growing economies in the region next year, expanding at rates of 3.5% or above. On the other end of the spectrum, Italy will be the region’s laggard, growing at 1.2%. Among the remaining major economies in the region, Spain will outperform the rest with 2.6% growth. Germany is seen expanding 1.9%, followed by France at 1.7%. 


See the full FocusEconomics Euro Area report


GERMANY | Economy shows no sign of losing steam


Angela Merkel’s re-election increased the prospect of institutional reforms in the EU, but her ability to deliver change is likely limited by complicated coalition talks that are expected to last until after Christmas. The so-called Jamaica coalition between Merkel’s CDU, the Greens and FDP is the likeliest outcome; the FDP, however, wants the CDU to relinquish control over the finance ministry and questions French President Emmanuel Macron’s proposed Eurozone reforms. The German economy, meanwhile, appears unfazed. Recent monthly data has been encouraging, with industrial production back in full swing after a brief summer lull that had suggested a loss of growth momentum. Consumers remained upbeat about the economy in October, and solid confidence levels have supported private consumption, which also benefited from strong labor market dynamics. This follows robust industrial production that outperformed market expectations in August; buoyant external sector data pointed to solid foreign demand for German goods despite a strengthening euro.


The economy is expected to grow robustly next year on the back of improving labor market conditions that should translate into solid wage growth. This bodes well for private consumption going forward, after a dent in Q3 2017 as inflation reduced consumers’ purchasing power. Sustained business confidence is also likely to result in fixed investment growth, while the external sector is also set to continue spurring growth. FocusEconomics panelists foresee GDP growth at 1.9% in 2018, up a notch from last month’s estimate, and 1.7% in 2019.


FRANCE | Government unveils cost-cutting 2018 budget 


Emmanuel Macron’s government presented its first budget to the legislature on 17 October. The bill proposes EUR 10 billion in tax cuts and investment of EUR 56.3 billion over five years, of which EUR 15 billion would be used to finance professional training programs to lower stubbornly high youth unemployment. Cuts in public consumption of EUR 16 billion infuriated the political opposition, which argued that they would disproportionately impact lower-income families. With these cuts, the government not only plans to lower the fiscal deficit to under 3.0%, which would bring it in line with EU fiscal rules for the first time since 2008, but also to lower public debt levels by five percentage points in the next five years. The bill was presented at a time when economic activity seems to be gaining steam. Consumer and business confidence remained above their long-term averages throughout the third quarter, and the manufacturing PMI reached a multi-year high in September, which bodes well for private consumption and fixed investment growth.


The country’s economic outlook is promising. Macron’s ongoing drive for reforms, low inflation, a strong euro and high optimism among firms and households should propel strong growth in fixed investment and private consumption. Panelists participating in the FocusEconomics Consensus Forecast expect GDP to grow 1.7% in 2018, which is up 0.1 percentage points from last month’s forecast. For 2019, the panel foresees growth of 1.6%.  


ITALY | Government skips VAT hike, targets higher fiscal deficit for next year


Despite structural weaknesses, and a marginal downward revision to Q2 quarter-on-quarter GDP growth, the economy seems to have stabilized on a path of moderate recovery. In August industrial production continued to expand robustly, benefiting from rising external demand for metallurgical and pharmaceutical products. Moreover, the unemployment rate ticked down, and the number of employed people increased. Nevertheless, improving labor market conditions seemingly failed to translate into higher consumer spending—as suggested by the second consecutive month of year-on-year declines in retail sales—likely due to stagnant wage growth, and the still sluggish construction sector. In mid-October, the government presented its 2018 budget, one of its last legislative measures before next year’s election. The proposed budget includes tax incentives for firms to hire young people and invest in new machinery, and avoids the VAT hikes previously set up for next year. Nevertheless, this would come at the cost of a wider fiscal deficit in 2018, which the government now projects at 1.6%—higher than the 1.0% expected without the policy changes.


Growth should be modest next year, helped by reasonably solid business investment and external demand, but held back by softer household spending. The massive stock of public debt limits the government’s room to maneuver and weighs on the banking system, limiting potential growth and posing stability risks, which could worsen if the ECB tightens its monetary policy. FocusEconomics Consensus Forecast panelists project a 1.2% expansion in 2018, up 0.1 rom last month’s forecast, and 1.0% growth in 2019.


SPAIN | Incoming data remains upbeat; crisis in Catalonia escalates


While the impact of heightened uncertainty over Catalonia remains to be seen, the Spanish economy fared well throughout Q3. Recent data points to a bounce back in growth momentum in September, boosted by a pick-up in business activity as evidenced by a higher PMI in both manufacturing and services. Retail sales expanded at an accelerated annual pace in August. An improved performance in exports, led by a thriving tourism sector, yielded a stronger current account in July. Moreover, survey-based data shows economic sentiment rose for the third consecutive month in September, to the highest level since December 2015. On the downside, industrial output growth softened for the third consecutive month in August. Despite recent improvements on the economic front, on 16 October the government cut its annual GDP growth forecast to 2.3% for 2018 compared to its previous estimate of 2.6%, citing political turmoil in Catalonia, which accounts for 19% of the country’s GDP.


Growth is expected to remain healthy in 2018, buoyed by a robust external sector and stronger private consumption amid improved labor market dynamics. FocusEconomics panelists project the economy to grow 2.6% in 2018, which is unchanged from last month’s forecast. Analysts have so far mostly refrained from cutting their estimates, but have indicated that forecasts may be subject to cuts in the coming months. For 2019, panelists project the pace of economic expansion slowing to 2.2%.  


MONETARY SECTOR | Inflation steady in September


More complete data confirmed that harmonized inflation was steady at August’s 1.5% in September, the highest reading since April. Although inflation continues to linger below the ECB’s target of just under 2.0%, solid growth momentum and a scarcity of eligible assets have led a number of analysts to project that the ECB will announce a tapering of its bond-buying program at its meeting to be held on the 26 October.


The FocusEconomics panel sees inflation remaining moderate next year and averaging 1.4%, which is unchanged from last month’s forecast. In 2019, price pressures are seen picking up modestly and inflation is projected to average 1.6%.


Get the full FocusEconomics Consensus Forecast Euro Area


Written by: Angela Bouzanis, Senior Economist

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