Euro Area: Downward Revision to Regional Outlook

The outlook for the Euro area’s 2014 GDP growth deteriorated this month following two consecutive upward revisions. FocusEconomics panelists revised their growth expectations down a notch to 1.1%. The deterioration was driven by downward revisions to 6 of the 18 countries covered (Estonia, Finland, Ireland, Italy, the Netherlands and Portugal). The outlook for two economies improved (Luxembourg and Slovenia) and it was unchanged for the remaining ten economies. Panelists expect the Euro area economy to accelerate slightly in 2015 and forecast a 1.5% expansion in GDP, which is unchanged over last month’s projection.

Infographic Euro Area June 2014

Cyprus is expected to be the worst performer in 2014 with a 4.5% contraction, followed by Slovenia, where economic growth is expected to be flat. On the other end of the spectrum, Latvia and Luxembourg are expected to be the strongest performers in 2014, expanding 3.9% and 2.3% respectively. Among the region’s major economies, Germany is projected to grow at the fastest pace with a 1.9% expansion, followed by Spain with a 1.0% expansion and France with 0.9% growth, while Italy is expected to experience a timid 0.5% expansion.

The downward revision to the regional outlook came on the back of recent indicator releases, in particular the flash estimate of the region’s Q1 GDP, which suggest that the Euro area recovery may be weaker than expected. GDP expanded a seasonally-adjusted 0.2% over the previous quarter in Q1, which was in line with the result recorded in the last quarter of 2013, but fell short of market expectations. The result reflected strong accelerations in Germany and Spain, which compensated for weaker performances in the other major regional economies.

Q1 GDP Results Suggest Recovery Will Be Slower Than Expected

Industrial production and unemployment data corroborated the view that the recovery is struggling to gain momentum. In March, industrial production contracted a seasonally-adjusted 0.3% over the previous month, which contrasted the 0.2% expansion recorded in the month prior. Moreover, industrial output dropped 0.1% on the year, which marked the first contraction after six consecutive periods of improvement. Meanwhile, the unemployment rate was stable at 11.8% in March for a third consecutive month. The result, which was only 0.2 percentage points shy of the region’s all-time record of 12.0%, continues to be underpinned by the persistent divergence between the core economies and the peripheral countries such as Greece and Spain.

Survey-based indicators, which had been improving continuously over the course of the past months, also took a small hit. The Markit Composite PMI Output Index flash estimate inched down from 54.0 in April to 53.9 in May. Despite May’s moderation, the composite PMI has been above the 50-point threshold that signals a stable economic outlook since July of last year, thus pointing to a continuing expansion in economic activity in the months ahead. Indeed, according to Markit, the reading for May implies a 0.5% GDP expansion in the Euro area in the second quarter, which would represent an acceleration over the first quarter’s result.

Surprising European Elections Result Source of Concern

In the political arena, the results of the 25 May European parliamentary elections threaten to add instability to the political scenario as euro-skeptic and populist parties had a strong showing across the region. The most surprising result was in France, where the right-wing National Front (FN) received the most votes at 25.4%. The result poses a great challenge to the Socialist government led by François Holland, which already experienced a strong defeat in local elections in March. In Greece, the radical left anti-austerity SYRIZA movement led by Alexis Tsipras won, although it failed to gather sufficient support to challenge the Samaras administration.

The flow of economic news from the region was broadly positive over the course of the month. On 17 May, the Portuguese government announced that the country had officially exited the international bailout program that began in May 2011. Portugal is the second EU country to exit a full bailout; Ireland exited its bailout at the end of last year. A sign that Portugal has regained investor confidence is evident in that the government will not resort to a precautionary credit line to smooth the transition (see details on page 139). Ratings agencies also showed positive sentiment regarding other peripheral economies: Standard and Poor’s upgraded its rating for Spain while Fitch upgraded Greece’s rating.

Inflation Remains in “Danger Zone”, ECB Action Expected in June

Annual headline inflation rose from 0.5% in March to 0.7% in April. Despite the pick-up, there are still concerns that persistent low inflation may cripple the incipient recovery as inflation was in what ECB President Mario Draghi called the “danger zone” of below 1.0% for the sixth consecutive month. Within this setting, many are calling on the ECB to intervene. At the latest policy meeting on 8 May, Draghi, while keeping the main refinancing rate unchanged at the record-low of 0.25%, announced that, “the Governing Council is comfortable with acting next time.” This is a clear signal that the ECB could intervene as early as the next meeting on 5 June.

Against this backdrop, FocusEconomics Consensus Forecast panelists lowered their inflation projections this month. They expect inflation to average 0.8% in 2014, which is down 0.1 percentage points over last month’s forecast. In 2015, inflation is expected to accelerate to 1.3%, which is unchanged over last month’s projection.

Note: This is an excerpt from the FocusEconomics Consensus Forecast Euro area – June 2014, published May 27th, 2014. The full report (170 pages, covering all 18 Eurozone member states is available for immediate download at the FocusEconomics Online Store). For more information and a free sample of the report please visit our website.

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