Euro zone: Muddling through

ECB:s new Outright Monetary Transaction (OMT) bond purchase programme, promising to buy an unlimited amount of government bonds on the secondary market, helped boost financial market sentiment. Yields have come down in Spain and Italy. However, there is still a lot of uncertainty surrounding the OMT programme and little indication that a Spanish bail-out application is imminent. Meanwhile, the focus is shifting back to Greece. A stand-off between international lenders and Greek authorities has put the 174bn bail-out programme in peril. Its aim of reducing Greek government debt to 120% of GDP by 2020 is too optimistic. Most euro zone indicators have worsened recently. The Composite Purchasing Managers Index (PMI) fell to 45.4 in September. The Economic Sentiment Index points to falling GDP in the third quarter but has recently been too pessimistic about growth. Hard data provide a somewhat more positive picture. Exports have continued to perform well, although the effects of euro appreciation have yet to feed through. Industrial production is showing resilience. Retail sales beat expectations in August. The labour market continues to deteriorate in line with expectations. Euro zone GDP is expected to fall by 0.5% in 2012, followed by a return to positive territory with marginal growth of 0.1% in 2013. In 2014 growth will accelerate to 0.9%. The forecast has been revised downward slightly for 2012 and 2013. Germany continues to sustain euro zone growth. The IFO business sentiment index decreased in September, but figures for trade and industrial production suggest that the economy made a good start to the third quarter and should expand. Indications of a worsening labour market have yet to affect the unemployment rate. Euro zone inflation accelerated in September but falling energy/food prices along with weak economic activity imply that headline inflation will decelerate before long. The ECB kept the refi rate on hold at its October meeting and the market only assigns a small probability of another rate cut during the remainder of 2012. No new major policy initiatives were presented and there was little more information on what conditions must be fulfilled before any OMTs are undertaken; there is still no good answer to how the ECB will decide whether OMTs are needed. GDP forecasts
Per cent 2012 Euro zone France Germany Italy Spain
Source: SEB

FRIDAY 12 OCTOBER 2012 Andreas Johnson SEB Economic Research +46 8 763 80 32 andreas.johnson@seb.se

Key data Percentage change 2013 0.1 0.3 0.9 -0.6 -1.2 2014 0.9 0.7 1.6 0.3 -0.1
GDP* Unemployment** Inflation* Government deficit***
Source: Eurostat, SEB

2011 2012 2013 2014 1.4 10.1 2.7 -4.1 -0.5 11.2 2.5 -3.3 0.1 11.9 1.6 -2.7 0.9 12.3 1.5 -2.2

-0.5 0.3 0.8 -2.1 -1.7

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

Economic Insights

INDICATORS AND GDP Most indicators worsened in September. PMIs for all of the big four economies are now well below the 50 level although there was an improvement for Germany. The Economic Sentiment Indicator (ESI) points to substantial falls in GDP but the indicator has been too pessimistic in recent quarters. Consumer confidence has decreased further and has deteriorated sharply in Germany. Confidence indicators remain depressed in the construction sector and fell further for industry and retail sales in September. Germanys IFO business sentiment index has decreased for 5 consecutive months and was just above the longterm average in September. The ZEW investor sentiment indicator improved, however. Euro zone GDP is expected to fall by 0.5 % in 2012. In 2013, GDP is expected to grow by 0.1% followed by acceleration to 0.9% in 2014. The forecast for 2012 and 2013 has been revised downward by one tenth of a percentage point compared to the August issue of Nordic Outlook. GDP is expected to fall by 0.3% quarter-onquarter in Q3.

Economic Insights

LABOUR MARKET AND INDUSTRY The labour market continues to weaken and unemployment in the euro zone has reached a new record level of 11.4%. The number of unemployed has risen for 16 months running and was 18.2 million in August. Employment has been decreasing in year-on-year terms for three consecutive quarters. Unemployment in the peripheral euro zone economies has increased further. The Irish labour market shows signs of stabilisation, however. The unemployment rate reached 25.1% in Spain during August. The German labour market is still holding up well; the rate of unemployment has held steady at 6.8% since December 2011. However, there are signs of weakening; vacancies have been decreasing since January. Euro zone industrial production has been resilient and registered a monthly gain in July. Capacity utilisation edged down in Q3, however, and has been below the long-term average since the end of 2008. Low capacity utilisation will help drive inflation lower.

Economic Insights

FINANCIAL AND MONETARY INDICATORS, INFLATION Sovereign bond yields in Spain and Italy fell sharply in the first half of September following the unveiling of the OMT programme. Italian yields have recently stabilised just above 5% while Spanish ones remain below 6%. ECB loans to commercial banks have changed little; there is EUR 1.1 trillion in outstanding loans due earlier Long Term Refinancing Operation (LTROs). No new such ECB low-cost lending initiatives appear to be in the cards. There is still no real recovery for bank lending despite the LTROs. In August, the year-on-year growth rate was barely positive for lending to households and lending to non-financial firms decreased by 0.8%. M3 growth was disappointing as well and decelerated to 2.9%, moving further away from the ECB target of 4.5%. The resilience of exports likely reflects past falls in the exchange rate but demand from Asia has been steady as well. The recent rise in the euro suggests that conditions for exporters will worsen. Inflation accelerated to 2.7% in September (flash estimate) but the increase is unlikely to be the start of an upward trend. Food and energy inflation are likely to fall during the coming months, while weaker economic activity and reduced capacity utilisation will help to push down inflation. HICP inflation is forecasted at 2.5% in 2012, 1.6% in 2013 and 1.5% in 2014. Core inflation will fall further to 1.4% at the end of the forecast period.