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Monthly Report - Economic Outlook
Recovery continues in the euro area but the Greek crisis deterioratesRecovery continues in the euro area but the Greek crisis deterioratesRecovery continues in the euro area but the Greek crisis deterioratesRecovery continues in the euro area but the Greek crisis deterioratesRecovery continues in the euro area but the Greek crisis deterioratesRecovery continues in the euro area but the Greek crisis deterioratesRecovery continues in the euro area but the Greek crisis deterioratesRecovery continues in the euro area but the Greek crisis deterioratesRecovery continues in the euro area but the Greek crisis deteriorates

The macroeconomic situation is improving in all countries of the euro area except for Greece. The economic recovery has gradually consolidated over the first six months of the year in the euro area as a whole, supported particularly by stronger domestic demand but also with other favourable tail winds: low oil prices, the euro's depreciation and better financing conditions. All this has helped to strengthen the economic outlook in the short term. However, Greece is the exception to this widespread improvement. The latest episode of political uncertainty has led to a severe deterioration in the country's macroeconomic and financial conditions. Nevertheless, unlike what happened in 2012, the contagion to the rest of the euro area, and particularly to peripheral countries, is very limited. Several factors are acting as firewalls: the commitment of the European Central Bank (ECB) to defend the euro is much more credible now than in 2012, as is the commitment of the main countries in the euro area to continue creating a more robust institutional framework at a European level. Also of help is the more limited exposure of European banks to Greek financial assets and the improved macroeconomic situation of peripheral countries thanks to the efforts made over the last few years to reduce the public deficit and implement structural reforms that have strengthened long-term growth capacity.

The Greek tragedy continues. On 30 June the second bail-out programme ended without an agreement being reached between Greece and the institutions to temporarily extend the programme in place. Given this situation, the Greek government decided, in extremis, to hold a referendum for the Greek people to decide whether they would accept the conditions to extend the bail-out. The programme therefore ended without the last pending disbursement being made, leaving Greek public finances fully stretched and causing the Greek government to miss its debt payment to the International Monetary Fund (IMF). Moreover, the liquidity problems of Greek's banking system forced Alexis Tsipras's government to implement capital controls. All this has led to a scenario full of questions. For the moment, the upswing in uncertainty is having disastrous consequences at a macroeconomic level. Growth prospects have plummeted and Greece is once again facing an immediate future of deep recession.

The Presidents of the European Commission, the Eurogroup, the European Council, ECB and the European Parliament have proposed a roadmap to continue constructing the Economic and Monetary Union (EMU). The Greek crisis has once again highlighted the pressing need to complete the EMU's institutional structure. The report proposes, in the first stage between July 2015 and June 2017, to implement actions that do not require any change in European treaties. The aim of this first phase will be to progress in aspects that increase economic and financial integration. For example, banking union will be completed with a common deposit guarantee fund and a single resolution fund and the capital markets union will be set in motion. In the second stage, as from July 2017, the institutional structure of the EMU would be completed to achieve real and long-lasting convergence. To this end, the aim is to set up institutions that can handle macroeconomic shocks with greater guarantees. To finalise the process, EMU will be created with a system of common institutions that take decisions collectively on economic and fiscal policy issues.

The breakdown of GDP for Q1 shows that the recovery is becoming more robust. Growth in the euro area increased to 0.4% quarter-on-quarter in Q1 (1.0% year-on-year), supported particularly by the contribution from domestic demand (0.6 pps). The rise in public consumption (1.1%) and in private consumption (1.7%), as well as investment (0.8%), shows how domestic demand is currently the mainstay of the recovery. The foreign sector contributed negatively (–0.2 pps) due to lower growth in exports than imports, although its contribution should improve throughout 2015 and 2016 thanks to the euro's depreciation.

The economic recovery is spreading almost throughout the euro area. Improvement in the composite PMI activity index speeded up, reaching in June its highest level in four years and ending a more expansionary Q2 than Q1. The consolidation of the recovery is also becoming more generalised both by sector and by country. Increases were recorded in manufacturing and especially in services, the latter boosted by the strength of domestic demand. By country, of note is the acceleration in France's activity, posting its largest expansion in the composite PMI since 2011 Q3, predicting a good rate of growth for GDP in Q2. Germany's activity index, although higher than France's, was lower in Q2 than in the previous quarter. In the rest of the euro area, the rate of growth was faster than in the two core countries, recording the highest figure for the last eight years.

The positive trend in the euro area's labour market continues although it varies from country to country. Employment in the euro area grew by 0.8% year-on-year in Q2 and employment expectations suggest this improvement will continue in the next quarter, particularly in the services sector. Although starting from different levels, the improvement in the rate of job creation was very marked in Spain (2.9%) but more modest in Italy (0.3%) and France (0.0%). In fact, the French government has passed a reform of the labour market for SMEs within its so-called «Macron Act» to encourage job creation. This reform reduces compensation for wrongful dismissal in SMEs (both for companies with fewer than 20 workers and those with more than 20 but less than 299). The reform thereby attacks, albeit timidly, the problem of the dual nature of the labour market, slightly reducing severance pay and making the final sum of compensation more predictable. It also delays the regulatory requirements for companies depending on their size, helping to eliminate obstacles to expanding the workforce.

Inflation continues to recover in spite of a slight decline in June. The year-on-year change in the harmonised index of consumer prices (HCPI) for the euro area stood at 0.2% in June, 0.1 pps below its level the previous month, partly due to the fall in the energy component. In spite of this drop, we expect inflation to continue rising in the euro area over the coming months, reaching 1.5% by the end of year. Higher oil prices, more expensive imports due to the euro's depreciation and the consolidation of domestic demand should help this to be the case. By country, the decline in German inflation came as some surprise (from 0.7% to 0.1%), although this was the result of temporary factors such as May's increase in leisure and tourism prices. We do not expect this decline to continue for long given the good performance of the Germany economy and especially its labour market, with strong wage rises expected for 2015.

The foreign sector revives. The euro's depreciation is boosting the euro area's exports. One example of its dynamism is April's 6.8% year-on-year increase in exports of goods from the euro area to the rest of the world, continuing the improvements recorded in previous months. For their part, imports rose to a lesser extent (2.5% year-on-year), to some extent due to a lower energy bill. The trade balance between January and April was 69% higher than the figure reached one year ago. We predict that the moderation in energy prices and sustained depreciation of the euro, especially once the Federal Reserve starts to raise interest rates, will continue to support the export sector.

The economic improvement reaches companies, albeit unevenly. In October 2014 and March 2015, the net share of firms with increases in earnings was 15% for large firms and 6% for medium-sized firms while this decreased for small and microfirms (5% and 21% respectively), according to the euro area's survey on the access to finance of enterprises (SAFE). This was due to increased turnover as well as the stabilisation of labour costs and reduction in other company costs, including financial. There was also an improvement in the availability of external financing for firms, in particular large companies. A larger percentage of these saw net rises in available financing (in the form of loans and bank overdrafts) although small and medium-sized firms also perceived improvements. These easier credit facilities for companies demonstrate how the recovery is now being felt in the real economy. By country, it is worth noting the increase in the net share of firms stating an increase in credit availability in Germany (14%) and especially in Spain (30% compared with 11% for the previous six months of the year).

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