Euro zone: Out of recession but slow recovery

After six quarters of recession, euro zone GDP finally grew again in the second quarter of 2013. We foresee a positive trend in GDP, current account, government deficits and unemployment, but very troubling levels of these variables will hold back demand. The euro zone is on a less unstable footing, and the intensity of the crisis is lower, but it is far from over. We see stabilisation at the moment; recovery is still a bit ahead of us. Developments so far since the August issue of Nordic Outlook are in line with our forecast. Following the 0.3 per cent quarter-on-quarter growth in the second quarter of 2013, we expect zero q/q growth in the third quarter and 0.2 per cent in the fourth. The fourth quarter of 2013 will be the first with positive year-on-year growth figures. GDP will decline by 0.5 per cent in 2013 and increase by 0.8 per cent in 2014 and 1.7 per cent in 2015. The European Central Bank has promised to do whatever it takes to save the euro, but positive data showing that the euro zone has left its recession behind has had a favourable effect on financial markets. Since the start of 2013, government bond yields have continued to fall in the crisis-hit GIIPS countries. We expect that partly due to weak growth, low inflation, politicians not moving fast enough with reforms and problems associated with a still weak banking sector in southern Europe, the ECB will cut its refi rate by 25 basis points in December and that further LTRO lending is likely. GDP forecasts Per cent
2012 Euro zone France Germany Italy Spain
Source: SEB

TUESDAY OCTOBER 8, 2013

Daniel Bergvall
SEB Research +46 8 763 85 94

Key data Percentage change 2013 -0.5 0.2 0.5 -1.7 -1.4 2014 0.8 0.8 1.7 0.6 0.4
GDP* Unemployment** Inflation* Government deficit***
Source: Eurostat, SEB

2012 2013 2014 2015 -0.6 11.4 2.5 -3.7 -0.5 12.1 1.5 -2.9 0.8 12.0 1.0 -2.5 1.7 11.5 0.9 -1.9

-0.6 0.0 0.7 -2.8 -1.9

* Percentage change, ** Per cent of labour force, *** Per cent of GDP

Economic Insights

INDICATORS, CONSUMPTION AND GDP Indicators support the view that we will see a continuous but slow improvement. For the big four (Germany, France, Italy and Spain), composite purchasing managers indices are close to the expansion threshold of 50. In manufacturing, the situation seems a bit brighter, with PMIs for the big four converging just above 50 (except that France is just below 50). Since May, there has also been continuous improvement in the European Commissions Economic Sentiment Indicator (ESI). In August, the euro zone ESI rose to 95.2 from 92.5 in July. The different strengths of the economies are more visible in the ESI than the PMI, with Germany at a higher level than France, Italy and Spain. Also, the ESI is currently above its historical average in Germany but below it in France. Consumer confidence has improved in France, Italy and Spain, although the figures are still clearly below Germany. In August, the increase in retail sales excluding autos was just above zero and vehicle registration was still falling (as it has been in all months of 2013 except July). Germanys IFO business sentiment index has trended higher since April. Even if we expect growth in the second half of 2013 to be weaker than the strong figure for the second quarter, Germany will outperform most of its euro zone partners in 2014 and 2015.

Economic Insights

LABOUR MARKET AND INDUSTRY The labour market is still weak and unemployment has been stable at a historically high 12 per cent since the start of 2013. One positive sign is that the number of unemployed fell for the third straight month in August, although by only 5,000 people, with over 19 million unemployed (12 per cent, unchanged since July). On the negative side, employment continued to fall during the first quarter of 2013 (-1,0 per cent) and there are signs that decreased labour force participation is contributing to unemployment not reaching even higher levels. There is still a mixed picture in the labour market, with German unemployment showing strength (a historically low 5,2 per cent in August, by Eurostats definition), in France levelling out at 11 per cent and in Spain and Italy just over 26 and 12 per cent respectively. Irelands jobless rate seems to have peaked and but is only marginally down during 2013, underscoring that making unemployment fall will be a long, drawn-out process for crisis-ridden countries. In the second quarter of 2013, capacity utilisation improved but industrial production remained weak. In July, industrial production continued to fall but an improvement in manufacturing sector confidence indicators (both the European Commission measure and PMI) is signalling that performance will improve during the rest of 2013. Portugal and Spain have seen their exports grow surprisingly strongly in recent months: a positive sign that internal devaluations are paying off, but it is still too early to say that this is an improving trend.

Economic Insights

INFLATION, FINANCIAL AND MONETARY INDICATORS Inflationary pressure is still low and the euro zone inflation rate in September (flash estimate) was 1.1 per cent, down from 1.3 per cent a month earlier. We expect inflation pressure to remain subdued both in the near term and over the next couple of years, given an expected slow economic recovery, high unemployment and low wage pressure. We foresee HICP inflation of 1.5 per cent in 2013, 1.0 per cent in 2014 and 0.9 per cent in 2015. Low inflation makes debt adjustment more complicated. Even though the general economic outlook is getting more stable, developments are fragile and events that fuel uncertainty are keeping the heat up. Political turbulence in countries like Portugal and Italy, as well as when and where we will see additional support and easing of the debt burden, are examples. The road ahead will be bumpy, affecting financial markets and growth negatively, but we do not believe that developments will be severe enough to create a situation similar to 2008-2009. The ECBs current stand-by policy will come under increasing pressure, due to low and falling inflation, repayment of earlier Long-Term Refinancing Operation (LTRO) loans that will reduce surplus liquidity and weak bank lending. No new policy measures have been announced, but continued verbal interventions will not be enough. We expect the ECBs policy to change and continue to forecast that it will cut the refi rate at its December 2013 meeting by 25 bp to 0.25 per cent. In addition, additional LTRO loans may be necessary if liquidity drops further. Surplus liquidity close to EUR 200 bn has been associated with a rise in the Euro Overnight Index Average (EONIA), which the ECB does not want to see. Bank lending to non-financial corporations is continuing to fall. Declining GDP combined with weak indicators make companies hesitant about capital investment decisions, reducing the demand for new loans. Cross-border banking flows are falling, and even though ECBs refi rate is low, lending rates to small and medium-sized enterprises (SMEs) diverge, with higher rates in southern and eastern euro zone members than in northern ones. This is a pressing issue, especially since such countries as Spain, Portugal and Italy have a larger share of employment in SMEs than Germany, France or Finland. Getting rid of the debt overhang. IMF research has shown that in previous deleveraging processes, growth and inflation not reducing nominal debt have been the main drivers. The outlook for the euro zone indicates that these factors will not contribute much in the near term, making the process more painful.