The economic recovery takes hold

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March 11th, 2014

Improvement in the macroeconomic scenario forecast for 2014 and 2015. The European Commission increased its growth forecasts for Spain for 2014 by half a percentage point, from 0.5% to 1.0%. The government also announced an upgrade in its growth forecasts to 1.0% for 2014 and 1.5% for 2015, in line with the forecasts of "la Caixa" Research. Both cases are a reflection of the progress shown by short-term economic indicators and of the advances that have been made over the last few quarters to correct the main imbalances accumulated by the Spanish economy. All this has helped to gradually shift the debate on the state and prospects of the Spanish economy from a hopeful to an optimistic tone. However, although there are reasons to believe that the recovery is on the right track, we must also remember that many of the pillars on which this growth is based are still weak.

GDP growth is revised downwards but the significant progress made by household consumption and investment allow for a positive interpretation. According to the Spanish statistics institute (INE), the quarter-on-quarter growth rate of GDP was 0.2% in 2013 Q4, 0.1 percentage points below the initial estimate. This growth was achieved in spite of the significant drop suffered by public consumption which, according to the INE, fell by 3.9% quarter-on-quarter, a sign of the significant effort being made to adjust the public deficit. Although this figure is unlikely to be reduced to 6.5%, the target set by the EC, any deviation finally occurring will probably be minor. The other side of the coin is represented by household consumption and investment in capital goods, posting growth rates of 0.5% and 1.9% respectively. Exports also maintained a notable growth rate (0.8%), especially thanks to the good performance by tourism and exports of non-tourism services.

Business indicators augur a good start to the year. Both the PMI for manufacturing and for services rose substantially in January thanks partly to the upswing in orders from abroad. Both indicators are now above 50 points (52.2 and 54.9 respectively), figures historically associated with positive GDP growth. The role being played by external demand in this recovery in industrial orders, up by 4.6% in December, is also highly significant. This upward trend is also spreading to the different supply indicators: industrial production and electricity consumption in industry, for example, have also seen notable increases over the last few months.

The real estate sector is gradually coming closer to stabilising. Both the rate of decrease in house purchases and in prices have eased in the last few months. Purchases closed the year down by 2.2% year-on-year, a relatively moderate drop taking into account the increase occurring at the end of 2012 due to the end of tax incentives for buying a home. According to data from the Ministry of Public Works, prices dropped by 1.9% quarter-on-quarter in 2014 Q4, accumulating a 29.7% decrease since 2008 Q1. In both cases the recovery in the labour market and better growth prospects are expected to help restore the confidence required for activity in the housing market to gradually pick up. Although the excess supply is still high, which will make it difficult for the real estate sector to maintain a rate of recovery similar to those of the rest of the sectors in the short term, we must remember that this is a highly segmented market with a great degree of heterogeneity.

Domestic demand reacts positively. The reduction in uncertainty surrounding the economic environment and the improved outlook are helping domestic demand, which had remained stagnant due to precaution over the last few years, to gradually wake up. The consumer confidence indicator, for example, improved considerably in January and February 2014 and is now clearly above the figure posted in 2013 Q4. Retail sales have also enjoyed a positive trend for the last few months. Their rate of growth recorded in 2013 Q4 was, on average, 0.4% year-on-year, leaving behind thirteen quarters in negative terrain.

Domestic demand is being supported by the labour market. January's figures corroborate the change in trend for the labour market: the seasonally adjusted number of registered workers affiliated to Social Security increased for the fifth consecutive month. The services sector has particularly boosted job creation, although industry's good performance is also worthy of note, which has now stopped destroying jobs. Details of the trend in the number of registered unemployed are also helping to outline a somewhat more positive view of the economic situation. Specifically, in January the num ber of registered unemployed increased by 113,000, 23,000 fewer unemployed than the average increase for the last six years. The support that will be provided by the improved tone of the labour market for the recovery in domestic demand suggests that the risk of deflation is low, although neither should it be ignored. The rate of inflation fell back into negative terrain (–0.1% year-on-year in February compared with 0.2% in January), partly due to the trend in fuel and oil prices, a relatively volatile component and not too closely related to the underlying conditions of the Spanish economy. As has happened in the past, inflation will probably return to its upward trend as the recovery in domestic demand takes hold.

Credit is starting to flow to households and firms again. Although the stock of bank loans is still shrinking, its rate of contraction is slowing down. One sign of this is that, in December, credit fell by 9.8% year-on-year (compared with –12.6% in November). This slowdown in the credit squeeze is due to two factors: firstly, the effect of the sharp fall in credit recorded last year as a result of assets being transferred to the Sareb has faded and, secondly, an incipient upswing in the granting of new loans can be observed, growing by 4.3% month-on-month in December. This latest figure is particularly noteworthy as we can see that this improvement has taken place especially in loans to households for consumption and other purposes, which will support the recovery in domestic demand. This can also be seen in the bank lending survey carried out by the Bank of Spain, especially the increase in 2013 Q4 of loan applications in all three segments (companies, households for housing and households for consumption and other purposes), something which has not been observed since 2011 and which we expect to be repeated in 2014 Q1.

Spain's risk premium now stands well below 200 b.p. The prices at which the Public Treasury carried out its last debt issue in February continue to demonstrate the warm welcome given to Spanish debt by the markets, with new all-time lows even being set in some of the auctions. Considering the high level of public debt, this decrease in the average cost of the debt is good news. We expect this tone of investment to continue, boosted by the improved credit rating given by Moody's and the government's plan to continue implementing reforms, one of the aspects that are still attracting the attention of the investment community. In this respect, during the state of the nation debate, the President of the government announced further measures to encourage job creation and new fiscal reforms, such as those earning less than 12,000 euros being exempt from paying income tax.

Exports continue to support the economy's growth. The current account balance closed in 2013 with a historical 0.7% of GDP, considering the fact that there had been no surplus in the current account since 1997. During the last year, most of the improvement in the current account deficit has been due to the balance of goods, whose deficit has fallen by 1.4% of GDP. The increase in the services balance, namely 0.3% of GDP, has also been notable. Although exports slowed down over the last few months of the year, their outlook is still favourable. In fact, December's rise in exports has partly offset the slump observed in the preceding months. Moreover, the aforementioned PMI points to this improvement consolidating at the start of the year. The trend in imports must also be monitored very closely over the coming months: until a few quarters ago these were suffering from the slump in domestic demand but, as this recovers, so will imports. That will be when we find out which part of the improvement in the current account is structural and which part has been the result of cyclical factors.