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The economic recovery is advancing slowlyThe economic recovery is advancing slowlyThe economic recovery is advancing slowlyThe economic recovery is advancing slowlyThe economic recovery is advancing slowlyThe economic recovery is advancing slowlyThe economic recovery is advancing slowlyThe economic recovery is advancing slowly

There were no surprises at the European Council. As usual, June's institutional agenda was brimming with important meetings and summits. The outcome was also as usual: agreements on minimums, fragmented and restrained butin the right direction, helping to forge, little by little, a more robust economic and monetary union. The most relevant agreement reached at the European Council concerns banking union, one of the three pillars that must support the new EMU. Having already agreed that the ECB will be Europe's bank supervisor as from next summer, now it was time to definethe rules for resolving insolvent banks. In this respect, an order of seniority has been established for liabilities when a bail-in is required, making it clear that minority deposits and covered bonds are protected. This is to avoid confusing episodes in any future bank crises, such as those experienced by Cyprus last April. It was also agreed to create national resolution funds with harmonized rules which, within ten years, must reach at least 0.8% of the insured deposits. National funds are seen as an intermediate step towards creating a Single Resolution Mechanism (see the Focus «Insolvent banks: the Council opts for bail-in 2.0» for the details of this agreement).

Youth unemployment and SME credit were also debated. The European Council also agreed to mobilize 8 billion euros to implement measures to boost youth employment (Spain will receive 2 billion). These funds must be used to promote initiatives such as the youth guarantee, which aims to ensure a job or training for young people 4 months after they have either lost a job or left the formal education system. Regarding measures to reactivate credit for SMEs, the European Investment Bank, together with the EC, sent a report to the European Council proposing various options to provide guarantees for bank loans to SMEs, possibly involving national official credit institutes. The European Council undertook to promote this kind of measure and, over the coming months, should announce details of how this will be set up.

The economic recovery is advancing at the same pace as institutional reforms: slowly. As expected, the rateof contraction in activity slowed down in the first quarter (–0.2% in 1Q 2013 versus –0.6% in 4Q 2012 in quarter-on-quarter terms). However, the distribution of roles among those elements delaying the recovery and those helping it came as some surprise. This moderation in the rate of adjustment was not supported by exports or investment.In both cases the decline was practically the same as in 4Q 2012, –0.8% and –1.6%, respectively. However, a standstill is not expected for either case. The index of export expectations, for example, has recovered notably in the second quarter, reaching the same level as the beginning of 2012.

Household consumption surprised with an increase of 0.1%, exceeding even the most optimistic expectations. However, this is not a result of a widespread improvement in household income in euro area countries. The answer lies in Germany, a country where consumption grew by 0.8%. Moreover, this is showing no sign of losing steam. The wage rises recorded in Germany over the last few months have been notably higher than the euro area average. Growthin wage costs per hour has been above inflation for months now, helping households to gain purchasing power and therefore maintain good consumption figures. Furthermore, this is combined with a very healthy labour market: for the last nine months the unemployment rate has not moved from 5.4%, an all-time low. In Germany, therefore, domestic demand seems to be gradually waking up. This contrasts with the consumption trend in the other large countries of the euro area. In France it grew by a slight 0.1% quarter-on-quarter, falling by 0.5% and 0.2% in Italy and Spain, respectively.

The labour market is approaching a turning point.The average index for the second quarter from European Commission's survey on the intention to hire workers overthe next three months shows that the labour market's situation has improved compared with the first quarter inall sectors. The German labour market remains clearly in a better position than the rest of the countries but there has also been widespread improvement throughout the region.Of note is the trend in this index for Spain, where the services sector is already very close to level as from which, historically, jobs are created. After 5 years of horrendous trends in the labour market, eroding both the confidence of those who have lost jobs as well as those still in employment but who feel threatened by the high uncertainty, such signs of stabilization are fundamental for the situation to be gradually turned around.

Economic sentiment continues to follow a trend.In June, this index rose by 1.8 points to 91.3, its highest monthly increase for the last three years. Moreover, this improvement is due largely to a sharp rise in the consumer confidence index which rose to the level of summer 2011, standing at –18.8 points. The average for the second quarter (–21.0) was therefore higher than the first (–23.7). Nonetheless, it is still far below the average for the lastthree decades (–13). The German case is once again notable as its consumer confidence index advanced for the sixth consecutive month to –3.2 points and now stands above its historic average (–7.9). This positive trend in German consumer confidence once again confirms the improved outlook for the country's domestic demand which, after the strong growth in consumption in the first quarter, seems to be once again advancing significantly in the second. May's retail sales, up by 0.8%, point along similar lines.

Business indicators also support this scenario of gradual expansion. The 1.8 point rise in June in the confidence index for the industrial sector, another component of the general index of economic sentiment, confirms that, on the supply side, the situation also looks somewhat more optimistic.This agrees with the interpretation of other indicators of economic activity which have also had a better second quarter. The PMI is approaching levels compatible with economic growth. In June, this indicator reached its highest level in 15 months for the euro area, with increases both in services and manufacturing. This time France led the advance, thereby narrowing its distance from the German index. However, the French index still lags behind the euro area.

A change in trend for industrial production is increasingly likely. In April, and for the third consecutive month, industrial production in the euro area posted positive figures (0.4%), boosted by the improvements in Germany (1.2%) and France (2.3%), as well as a smaller decline in the periphery countries. This brings the year-on-year rate of change increasingly closer to stabilization (–0.6%). One of the components that have been performing better over the last few months is capital goods. In April, for example, this rose by 2.7% month-on-month after two months with growth close to 1%. Consequently, the bad performance by investment in the first quarter does not look like being repeated in the second.

The recovery will continue to enjoy the support of easy monetary policies. After the shift in the Fed's monetary policy, the ECB took great pains to remind people that, in the euro area, activity remains very weak and there are still no signs of inflationary pressures that make any change in monetary policy necessary. In fact, although inflation rose by 0.2 percentage points in May to 1.4% year-on-year, this remains at a comfortable level for the ECB and, given the weak demand in the euro area as a whole, it is unlikely to climb too far.

Of note is the half-point rise in Germany's inflation to 1.6%. The increase has been considerable and, in general, quite a lot more than the change occurring in the rest of the euro area countries. Given the good performance by domestic demand and the likelihood that this will improve further, the positive difference of German inflation with the euro area (the historical average is –0.4) could fuel debate regarding the appropriateness of the ECB maintaining an expansionary policy. However, the first point to take into account is that, although the increase has certainly been notable, the inflation rate is still at a relatively low level. Moreover, price rises have not been generalized across all items but rather concentrated in foods and gambling, while the cost of energy, telecommunications and financial services has moderated. This leads us to believe that the upswing is due to temporary factors. We have therefore maintained our forecast for inflation for the whole of the year at 1.5%, a figure similar to that of the consensus of analysts, namely 1.6%.

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