Developed Europe: Economic Review May 2011
Thomas White International
June 13, 2011
All through May, Developed Europe’s debt woes dominated market sentiment, in not only the region but also other parts of the globe, as European leaders failed to reach a consensus on how Greece should deal with its debt repayments, given its weakening public finances. Rating agency Standard & Poor’s downgrade of Greece’s debt in early May buttressed speculations that the country might discuss with its bondholders the possibility of a delay in the repayment of its bonds.
Such a step, if it is taken, will certainly give breathing space to the beleaguered nation, but policy makers fear that it will unnerve the country’s creditors and European financial markets further. Meanwhile, Greek bonds saw another round of selloffs.
Several other developments, such as the surge in the bond yields of other indebted nations like Spain, Ireland, and Portugal; S&P’s downgrade of the outlook for Italy’s sovereign bond from stable to negative; electoral setbacks for the ruling parties in Spain and Germany; and the arrest of the IMF chief, a key leader of the discussions on Greece; also added to investors’ unease. The various economic data reported during the month did not provide much solace either.
At a Glance
- Germany: PMI data for May showed slight moderation in manufacturing activity, and economic sentiment deteriorated. Exports, though, continued to surge.
- U.K.: Consumer spending showed a declining trend, although holiday-filled April recorded robust retail sales. The housing market remained weak, with house prices declining in April.
- France: The country’s manufacturing sector growth slowed down, but the services sector held up well. GDP expanded 0.8 percent in the first quarter of 2011.
- Italy: The outlook on Italian debt was downgraded from stable to negative, reflecting political uncertainty and sluggish economic conditions in the country.
- Spain: First-quarter GDP recorded modest growth while the unemployment rate climbed during the period. The ruling party suffered heavy losses in local elections.
- Portugal: A €78 billion bailout package was finalized for the country. Bailout terms involve strict austerity measures as well as a plan to recapitalize Portuguese banks.
- Greece: Debt woes intensified with no plans in sight to deal with future repayments. GDP expanded 0.8 percent in the first quarter.
In the beginning of the review period, the European Union’s (EU) statistics agency Eurostat reported that its preliminary estimate of the Euro-zone’s annual inflation rate had touched a 30-month high. The report intensified fears that amid this unabated rise in prices, the European Central Bank (ECB) would implement further rate hikes. This move would likely be disastrous for the economies struggling to cope with high levels of unemployment amid severe debt problems. Nonetheless, the ECB soon allayed those fears as members voted to keep its main policy rate unchanged for the time being and an ECB governing council member confirmed that any future decision on a rate hike would be taken only after considering projections for the Euro-zone economy.
Eurostat also reported that the Euro-zone’s industrial output declined in March compared to February, the first fall in six months. Compared to a year ago, output did expand in March, but the rate of growth was the lowest in 11 months. Eurostat’s data was in sync with the results of survey information provider Markit, which was conducted in the Euro-zone. Markit’s initial estimate of the Euro-zone’s composite output in May, which takes into account both the manufacturing and the services sectors, fell from April to a seven-month low. The Euro-zone’s export-driven manufacturing sector has experienced steady growth on the back of increasing demand from emerging economies. However, developing nations have lately been taking measures to put a temporary brake on growth in the wake of rising inflation. Understandably, growth in the Euro-zone manufacturing sector is also slowing down, which is likely to continue until momentum picks up again in countries such as China and India.
The Markit survey indicated that in the four months until May, the number of jobs in the Euro-zone grew at the slowest pace compared to the past few four-month periods. Further, employment growth continued to be skewed, with Germany and, to a lesser extent, France accounting for the largest number of jobs created.
The most encouraging revelation of the Markit survey was a considerable strengthening of the Euro-zone private-sector growth in April. However, retail sales in the single-currency bloc dropped in March, according to the survey. Non-food items contributed the most to the retail sales decline, indicating that households have been curbing their consumption of discretionary goods owing to rising inflation and the weak employment outlook.
In May, economic sentiment weakened in the Euro-zone but remained unchanged in the broader European Union. The outlook for industry deteriorated in both the regions owing to firms’ low production expectations and discouraging order book status.
Germany: PMI data indicate slight moderation in growth
German manufacturing activity, which has so far been growing steadily on the strength of demand from emerging economies, reported lackluster data in May. A well known Purchasing Managers Index (PMI) for Germany slipped to 56.4 in May from 59.2 in April. Since a reading over 50 indicates growth, it is evident that the Euro-zone’s biggest economy continues to see robust activity in its manufacturing sector, but the momentum seems to be flagging. The PMI data was in line with a German economy ministry report released in early May. According to the report, the country’s manufacturing orders dropped 4.0 percent in March after rising 1.9 percent. The latest slowdown in manufacturing activity is likely a lagging effect of the drop in orders in March, possibly owing to the deceleration in Chinese economic growth.
In line with the Markit survey report on Euro-zone retail sales, German retailers too reported a greater-than-expected sales drop in March, according to data released by the country’s Federal Statistics Office (FSO) toward the beginning of May. The sales figures registered a decline compared to not only February but also the year-ago period. However, subdued retail sales in Germany are believed to be a result of weak consumer confidence owing to recent geopolitical developments rather than domestic factors.
German economic sentiment deteriorated again in May because of the continuing Euro-zone debt crisis and a slowdown in the country’s chief export markets, such as the U.S. and China. On a positive note, though, the outlook for Germany’s export sector remains optimistic. The country’s exports surged to a record high in March, according to the FSO. The recent drop in commodity prices and a decline in the value of the euro should continue to help the sector in the short term.
German GDP expanded 1.5 percent in the first quarter of 2011 compared to the previous quarter, underscoring the country’s continuing importance as the engine of growth in the Euro-zone.
U.K.: Consumer spending likely in declining trend
After the euphoria of the royal wedding in April, the British economy did not have much to cheer about in May. Most of the data released during the month showed that the economy still has a long way to go before it is nursed back to health completely. The Office for National Statistics reported that household spending slid 0.6 percent in the period from January to March, recording the biggest quarterly decline since the second quarter of 2009. It is noteworthy that consumer spending seems to have started deteriorating even before the full effect of recent public spending cuts have been felt. On the flip side, though, the Bank of England is now unlikely to hike interest rates despite rising inflation.
However, retail data for April and released in May painted a contrasting picture. On the back of the Easter holidays, the royal wedding, and warm weather, retails sales during April grew at their strongest pace in five years. But the holiday-dominated month was probably an exception and did not appear to reflect any trend.
The U.K. housing sector continues to reflect a pessimistic outlook. House prices slid 1.4 percent in April compared to March, recording the biggest annual fall since October 2009. The data indicate that weak consumer confidence and the limited availability of mortgages are keeping home buying restricted. Underscoring this trend, the Bank of England reported that lending to homebuyers and consumers increased less than expected in March.
On the bright side, however, the U.K.’s unemployment rate for the three months until March declined from the previous quarter. The number of unemployed people in the country reduced by 36,000 to 2.46 million during the period.
France: Services sector the main driver of growth now
France, like the broader European Union, may now have to rely on its services sector for growth as the momentum in its manufacturing sector seems to be flagging due to subdued growth in emerging economies like China, the main market for European industrial exports. An early version of Markit’s composite French Purchasing Managers’ Index (PMI) fell to 60.5 in May from 62.4 in April. While the services PMI slipped to 62.8 in May from 62.9 in April, when the indicator had touched its highest level since September 2000, the factory sector PMI declined to its four-month low of 55.0 in May from 57.5 in April. The data indicate that growth in the manufacturing sector is likely peaking, but the services sector continues to hold up well and should drive GDP growth in the second quarter.
In the first quarter of 2011, France’s GDP expanded 0.8 percent compared to the previous quarter on the back of solid growth in its manufacturing production. The French government has expressed confidence that the economy will be able to record a matching performance in the second quarter too and meet its 2 percent GDP growth target for the year 2011, as it expects the strength in the French services sector to offset the effects of high unemployment in the country.
With manufacturing sector growth slowing down and the outlook for production weakening, French business confidence dipped to a three-month low in May. An indicator of confidence among French businesses fell more-than-expected to 107 in May from 109 in April. Notably, sentiment remained stable in the retail and construction industry, but weakened in the wholesale trade sector, reflecting the slowdown in the export market.
Italy: Downgrade of outlook on debt reflects political uncertainty
Citing its concerns about the Italian economy’s growth prospects and Rome’s ability to reduce its public deficit, rating agency Standard & Poor’s (S&P) lowered its outlook on Italian debt from stable to negative. The outlook downgrade means that there is a 33 percent chance of the Italian credit rating being lowered within the next 24 months. The downgrade hurt market sentiment at the time it was announced and may push up the cost of Italy’s borrowing costs in the short term. However, more importantly, the downgrade is a damning commentary on the current state of Italy’s economy and the political uncertainty prevailing in the country. Italy’s center-right coalition government has never been more fragile, with the prime minister on trial in several corruption cases and the coalition’s crushing defeat in recent local polls. The S&P downgrade is a reflection of market fears that the political gridlock may affect Italy’s debt-reduction plans.
Nonetheless, the demand for Italian debt has not been affected significantly following the downgrade of outlook. The difference between the yields of Italy’s riskier debt and safe-haven German debt did shoot up soon after the downgrade, but moderated later as Italy’s domestic investors bought more of their country’s bonds. It is noteworthy that 57.3 percent of Italy’s sovereign debt is held by domestic investors compared to 21 percent and 25.5 percent for Greek and Portuguese bonds. Therefore, Italy is somewhat less vulnerable to volatility in the global bond markets compared to other countries at the center of the European debt crisis.
Italy recorded a less-than-expected GDP growth of just 0.1 percent in the first quarter of 2011 as a slight improvement in its exports failed to compensate for weak domestic demand. In line with this data, the country’s retail sales declined 0.2 percent in March compared to February, according to a report released by national statistics agency ISTAT.
Spain: Unemployment increases amid sluggish GDP growth
In May, the ruling Socialist Party suffered heavy losses in Spanish regional elections, reflecting the mood among voters frustrated with high levels of unemployment and painful austerity measures. The election results have several implications for the Spanish economy and the market sentiment regarding Spain. Investors fear that political changes in Spain’s regions could now reveal much higher levels of debt at the country’s local government level than previously estimated, which would weaken the federal government’s fiscal position further. Secondly, the federal government may now find it more difficult to balance between annoying its electorate and implementing crucial austerity measures. In fact, the weeklong mass protest by angry Spaniards just before the elections are a sign of the hurdles the government is likely to face in the future while taking austerity steps.
Spain’s unemployment rate, the highest among developed economies, climbed from 20.3 percent in the fourth quarter of 2011 to 21.3 percent in the first quarter of 2011. Job losses were recorded across sectors and, alarmingly, more jobs were lost during the first quarter of 2011 than in the whole of 2010. According to Spain’s statistics institute INE, which released the figures, the manufacturing and construction sectors suffered the maximum number of job losses. The labor market data underscore the fact that Spain remains hobbled by austerity measures and rising production costs. Unlike Germany and France, Spain’s export sector does not employ a significant portion of the labor force. Therefore, any improvement in the labor market depends on domestic demand, which in turn remains restricted due to the high level of unemployment.
Spain’s first-quarter GDP grew just 0.3 percent compared to the fourth quarter of 2010, mirroring its stagnant economy.
Portugal: €78 billion bailout package finalized
As expected, the country took the final step toward receiving its €78 billion bailout package during May as the parliament of Finland, the only Euro-zone country that requires parliamentary approval to agree to bailouts, voted in favor of the bailout plan after days of intense debate. Before the vote, the Finnish parliament appeared sharply divided about Portugal’s bailout, stoking fears that the plan may get stalled.
The terms of the bailout plan impose tough austerity measures on Portugal, although the country’s prime minister has claimed that they are more lenient than those imposed on Greece or Ireland. The terms involve a freeze on government salary hikes until 2013 as well as a special tax on pensions exceeding €1,500 a month. Economic estimates based on the terms agreed between the government of Portugal, the European Union, and the International Monetary Fund signal a 1.5 percent-2 percent decline in Portugal’s GDP until 2012 and a record rise in the country’s unemployment rate. The bailout plan also envisages strengthening Portuguese banks’ capital position. Around 15 percent of the bailout package will be used to shore up the finances of the banks that fail to push up their capital ratios to new higher stipulations.
Portugal reported another positive development in May. The country declared that its budget deficit during the first four months of this year had declined significantly compared to the year-ago period. According to a statement released by its finance ministry, Portugal reduced its spending 3 percent and raised its revenue 17.4 percent during the period.
Owing to austerity measures Portugal has started to implement, the country’s GDP declined 0.7 percent during the first quarter of 2011 compared to the previous quarter. Since its output had shrunk in the fourth quarter of 2010 too, the country is now officially in a recession.
Greece: Plans in the pipeline for sale of state-owned assets
During May, Greece struggled to chalk out a definitive plan to deal with its immediate debt commitments, as it needs about €30 billion over the next year to fund its debt repayments. Seemingly, it has two options – to get another bailout from its European peers or to default on its obligations. Neither option is acceptable to other European countries and policymakers. The richer nations in the region are worried about the political cost of another bailout to Greece, while the European Central Bank is concerned about the impact of debt restructuring on sentiment in the bond markets and, subsequently, the step’s repercussion on the debt markets of other weak Euro-zone countries such as Ireland. A debt restructuring would also likely impose much stricter austerity measures on Greece, potentially crippling the country’s economy for years.
Debt restructuring is also undesirable because stricter austerity measures in the future could create unprecedented unrest in the country, as the government has not even been able to convince citizens about current austerity measures. A nationwide strike and demonstrations against new austerity measures stalled economic activity in the country in May.
Amid this unrest, Greece reported that it would speed up long-delayed plans to sell off state-owned assets worth about €50 billion over the next five months. The Greek government said that as much as €5.5 billion could be raised by the end of this year.
The only positive development during the month was news that Greece had managed to grow its GDP 0.8 percent during the first quarter of 2011 compared to the fourth quarter of 2010. Output expanded in the country after four consecutive quarters of contraction.
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