The European Commission's new economic forecasts: Fragile recovery continues, but problems remain

The latest Commission economic forecasts are out and the theme of a broad but still fragile recovery (combined with some gentle self-congratulations on the success of the current approach) has been continued. For the most part the forecasts are not hugely different from the Autumn 2013 ones, which we covered here.

We won’t do a country by country run down again, since little has changed. But we pick up on a few general themes below.

Inflation forecast cut
A metric which everyone is watching at the moment is inflation. As we have discussed before, March has been pegged as a key meeting for the ECB and is expected to be a defining choice over whether the bank takes more action to tackle inflation. The EC has cut its forecast for inflation from 1.5% to 1.1% for this year while last year’s has been revised to 1.3% from 1.5%. Despite the language being quite strong on inflation remaining low and subdued, these forecasts aren’t far from the ECB’s own and are unlikely to push them one way or another when it comes to taking further action. The graph also highlights that the view of core inflation (without energy or food prices) been on a slow decline for some time but is expected to melt upwards over the coming years. Again this fits with current ECB thinking rather than bucking against it.

Spain and Italy – diverging forecasts, but plenty of common problems
One of the more surprising points is that Spain has got the most substantial upgrade of all the big eurozone countries – with its 2014 growth forecast raised from +0.5% to +1%. At the same time Italy is the only big eurozone country whose growth forecast for this year has been revised downwards – from +0.7% to +0.6%. Similarly, on the unemployment side (while Spain remains in a much worse position) the forecast has improved somewhat for Spain and worsened for Italy. In any case, both continue to struggle with their large debt loads (more below), although new Italian Prime Minister Matteo Renzi might take the less than optimistic forecast as an important reminder of the reforms he needs to pursue, not unlike the ones Spain has undertaken…

Debt remains a problem in the eurozone
By 2015, seven eurozone countries are forecast to have public debt levels above 100% of GDP – Belgium, Ireland, Cyprus, Greece, Spain, Italy and Portugal. As the report warns, this debt overhang could become a drag on medium term growth, particularly when combined with other factors such as the knock on effects of years of depressed investment, high unemployment and falling productivity.

Borrowing costs for SMEs have come down but remain divergent in eurozone
As the graph highlights, there has been some improvement over the past few months. That said, borrowing costs for firms in France and Germany remain substantially below those in the periphery countries. Given the importance for SMEs, particularly in Italy and Spain, it is difficult to see a strong pick-up in economic activity or employment until SMEs can fund themselves effectively at reasonable rates.

Transition from export driven growth to a more balanced recovery
The EC suggests that the recovery is and will become more broadly balanced. As we have warned, particularly with regards to Portugal, becoming overly reliant on exports can be dangerous as it’s not clear that there will be sufficient demand to pull the economy out of its slump. That said, the Commission doesn’t entirely provide convincing ground for the significant turnaround in domestic demand and investment which is expected. With firms and households still weighed down by significant amounts of debt in much of the periphery and borrowing costs remaining high, it’s not yet clear that this can take place as quickly as is hoped. As the graph below shows, the turnaround needed is substantial.

Labour market continues to lag behind
Even if you buy into other parts of the recovery, it’s clear it hasn’t yet come close to improving the serious unemployment problem in much of Europe. Divergence is also expected to remain with many of the peripheral countries having incredibly high unemployment for the foreseeable future (well beyond the timeline of these forecasts).

And finally, seriously, what’s wrong with Finland? This data marks another bad day for the Finnish government, with the Finnish economy forecast to grow by only 0.2% this year, the slowest level behind Cyprus (-4.8%) and Slovenia (-0.1%), both embroiled in the eurozone crisis.

Spanish unemployment: A temporary turnaround?

New data on Spanish unemployment are out today. The headline figures look, once again, rather encouraging. The overall unemployment rate has fallen below 26% in the third quarter of the year, and there are 39,500 employed people more than in the previous quarter.

The number of unemployed people has gone down by 72,800 - which is the largest decrease in a third quarter since 2005.

However, a few points are worth making:

• The rise in the number of employed people is due to an increase in self-employed and temporary workers. The number of employees on permanent contracts has actually fallen by 146,300. One can see the glass half-full or half-empty here. This finding can mean that the Spanish labour market is becoming more flexible, or just that the increase in the number of employed people is driven by seasonal workers - especially in the tourism sector.

• Employment is growing in the services sector, but is decreasing in agriculture, industry and construction. Another sign that the improvement in Q3 figures could be tourism-driven. This is not, in itself, a bad thing - given tourism is definitely one of Spain's key resources and it is obvious that the Spanish economy needs to rebalance (away from construction). But it can't quite be seen as a permanent source of growth, since the flow of tourists is per definition dependent on which season of the year you're in.

• As we noted on this blog when the figures for Q2 came out, the number of active Spaniards (those working or actively searching for work) continues to go down - marking a further 33,300 decrease.

• Seasonally adjusted data show that the unemployment rate has actually increased by 0.21% from the previous quarter, and that the level of employment has not stopped going down since Q2 2008. 

Let's have a look beyond the (rather encouraging) headline figures on Spanish unemployment

The Spanish National Statistics Institute (INE) has this morning published its latest unemployment data. The headline figures look encouraging. In the second quarter of 2013, the number of unemployed people went down by 225,200 - and is now slightly below six million. The total unemployment rate now stands at 26.3%, while youth unemployment rate is 56.1%.

However, a few points are worth keeping in mind when assessing the importance of these figures:

• The figures are not seasonally adjusted, so the decrease is clearly linked to the arrival of the summer - when a lot more seasonal jobs are on offer. The two Spanish regions where the number of employed people increased the most were the Balearic Islands (Ibiza, Formentera, Mallorca and Menorca) and Andalusia - top tourist summer destinations.

• A similar phenomenon took place last summer. The initial, non-seasonally adjusted figures for June 2012 showed a 0.2% drop in unemployment from May 2012. However, once these figures were seasonally adjusted the result was actually a 0.2% increase. The graph below highlights this well, showing that there is a similar dip in unemployment every year when the summer approaches (data are from the EU's statistics office Eurostat, click to enlarge).

• Part of the decrease in the unemployment rate is also due to a reduction in Spain's active population (those working or actively searching for work) - 76,100 people less over the same period. To fully judge the importance of the figures, it is also worth looking at the level of employment which is not impacted by such a change in activity. The figures for June 2013 showed employment increased by only 149,000, much lower than the overall fall in unemployment.

• A final point to keep in mind is the on-going emigration of Spaniards. This has reached record levels with close to 60,000 Spaniards emigrating in 2012 and many immigrants also moving elsewhere. This is obviously linked to people dropping out of the active labour force. We may well see future declines in unemployment but they will be meaningless if they simply arise from less people actively searching for work or moving abroad to find work elsewhere.

Unsurprisingly, the Spanish government had predicted "good" data - and will probably hail the new figures as a success of its policies. But once the summer is over, as happened last year, the figures may ultimately tell a rather different story.  

The march of eurozone unemployment continues

An unstoppable march? Maybe. The consistent monthly practice of smashing unemployment records in the eurozone continued in April with the overall total reaching 12.2% while youth unemployment hit a whopping 24.4%.

• As the graph highlights (click to enlarge) youth unemployment has risen a staggering amount in some countries since the start of the crisis (for countries where April data is not yet available the latest month available was used).
• The problems in Greece are well documented but some very large economies also have some very serious problems with youth unemployment. In April it stood at 56.4% in Spain, 42.5% in Portugal and 40.5% Italy.
• The longer this goes on the more problems it will cause both economically and socially. It creates a split within society with many young people seeing a very bleak future; traditionally this has also fed populism and the rise of extreme political parties.
• Economically it hurts the long term productive potential of the economy as some of these young people see their productivity reduced by long stints out of work, while many others will look for work abroad potentially creating a 'brain drain' and worsening an already troubling demographic problems.

Where will Cypriot growth come from?

This is now emerging as the key question for Cyprus following the severe mishandling of its bailout. The financial services sector, along with real estate and related businesses, which accounted for around 30% of Gross Value Added in the economy is now essentially gone as a source of growth.

Cyprus’ main trading partners, Greece in particular, remain mired in recession. Its two largest banks – key employers – will be restructured and unemployment will undoubtedly rise. Meanwhile, the government will be cutting spending and raising taxes, laying off public sector workers and embarking on some strict labour and product market reforms – as part of the standard Troika bailout package. Many of these reforms are needed but as we have seen across Europe, when combined with other impacts mentioned above, a downward spiral can be created.

The key hope for growth remains tourism. However, with the euro remaining strong and the prospect for political and social unrest in Cyprus still high, it is difficult to see a huge boost in this area. It will continue to truck along but is unlikely to fill the gap left by other areas of the economy shrinking. As we have discussed before, the prospect of growth from large gas revenues remains a pipe dream for now.

With all of this in mind we have put together a comparison of some of the previous growth estimates, along with the implicit ones included in the latest troika report and some of OE’s initial (optimistic) projections (click to enlarge).

All of this remains uncertain, depending on when capital controls are removed and how investors respond but it does not make pretty reading. All previous hopes for the economy are off the table and expectations need to be severely adjusted. The Troika's estimates are very optimistic, particularly in terms of returning to rapid growth in 2015 and 2016. Furthermore, if the growth estimates included in the bailout prove to be overly optimistic it means Cyprus will, just as Greece did, require further financial assistance.

A turbulent Easter in Cyprus

Uncertainty continues to reign in Cyprus. Cypriot Finance Minister Michalis Sarris resigned this afternoon, seemingly confirming the earlier (denied) rumours that he had previously tried to resign and bringing to a close what must be one of the shortest stints as finance minister in recent history (35 days). To add fuel to the fire, initial reports suggest he resigned due to the on-going investigation into people moving funds out of Cyprus ahead of the bailout. Fortunately, unlike other aspects of the crisis, the Cypriot government has wasted no time in appointing a successor with Labour Minister Haris Georgiadis already lined up to fill the role.

Meanwhile, as we noted in today’s press summary (and have repeatedly suggested) the capital controls look set to last for much more than a week.We also highlighted some interesting comments by the President of the Cypriot Parliament Yiannakis Omirou who said:

“I would like to send a message to the Cyprus people that there is no other way, there is no alternative apart from freeing (the country) from the troika’s and the memorandum’s bonds…by leaving the troika and the EMS behind us, we will ensure our national independence, our national sovereignty, our moral integrity and our economic independence…If we remain bound by the Troika and the memorandum Cyprus’ destiny is already foretold and there will be no future.”

Clearly not one to mince his words.

Furthermore a draft version of the loan agreement between the EU/IMF/ECB Troika and Cyprus (the Memorandum of Understanding) was leaked yesterday. It drove home another point which we have flagged up before. Despite all the talk about depositors and banks, Cyprus is still getting a €10bn bailout, that will mean undergoing the fiscal consolidation and structural reforms (widely referred to as ‘austerity’) witnessed in the other bailout countries. The key points of the agreement confirm this:

• 7.25% of GDP in fiscal consolidation between 2012-2016.
• Freeze in public sector pensions and a two year increase in the retirement age.
• Implement a four-year plan as prepared by the Public Administration and Personnel Department aimed at the abolition of at least 1880 permanent posts over the period 2013-2016.
• Increase the statutory corporate income tax rate to 12.5%.
• Increase the tax rate on interest and dividend income to 30%.

These are but a few of the measures and the document remains incomplete. The impact on GDP is likely to be significant, while youth unemployment is already at 31.8% (total at 14%) – this is likely to rise substantially.

To add to all this, reports continue to abound about outflows of deposits before the bailout, while the banks were closed and people now trying to skirt the capital controls. Significant questions are being asked about the enforcement and implementation of all these rules. With a decision on whether to extend capital controls expected on Wednesday evening or Thursday morning the uncertainty is likely to continue.

Let's tone it down a notch: Comparing the UK and German debates on EU migration

No one picking up a UK paper will have failed to notice that there is some concern over EU migration on the British isles, with the debate being triggered by the end of so-called "transitional controls" for Romanian and Bulgarian workers (the countries joined in 2007).

As we've argued repeatedly, EU free movement has on the whole been beneficial for both Europe and the UK, but the issue must be handled with much care, given its exceptionally sensitive nature and the practical impact it can have on public services and certain sectors of the labour market.

But there's also a false perception in the UK that all of Europe wants to come to Britain to enjoy its superior welfare system. This is far from the truth and secondly, the UK isn't the only country that has concerns over EU migration. It is, however, the country in which the debate is the most hysterical. Philip Collins looks at this in today's Times.

Speaking in Parliament earlier this week, Work and Pensions Secretary Ian Duncan Smith said there was a “crisis” over rules on EU migrants’ access to services and welfare, particularly in light of the expiry of transitional controls on migrants from Bulgaria and Romania at the end of the year. The issue definitely needs to be looked at, and there are several things the UK needs to do (see here). The Commission also needs get its act together and drop its own-goal challenge against the UK's "right to reside" test - the test is a political hugely important filter to guard against welfare abuse. But crisis?

Duncan Smith did, however, rightly point out that other EU member states shared some of the UK’s concerns, specifically that “Germany has woken up at last to the reality that it might face a large net migration”.

So what is the nature of the corresponding debate in Germany? Well, there's a genuine concern. A recent position paper by the German Association of Cities generated a lot of coverage as it focused specifically on so-called ‘poverty migration’ from Bulgaria and Romania, particularly those from a Roma background. The report warned that these migrants arrived in cities already affected by relatively high unemployment and with severely stretched public finances, and that despite the transitional controls in place, migration from Bulgaria and Romania had increased six-fold since 2006.

In terms of the public response, German Interior Minister Hans-Peter Friedrich (CSU) recently warned that:

“Abuse of free movement could be explosive for European solidarity. If people in Germany feel that their solidarity and openness is being abused and our welfare system is looted then there will be legitimate anger. The message for the EU Commission is clear: Brussels has to take stronger account of situation of the local population in its decision making process.” 

Justice Minister Sabine Leutheusser-Schnarrenberger (FDP) has also stressed that "Many Roma flee their homes because of discrimination and resulting poverty… Poverty-related migration must be addressed at its roots." Germany has also said it might veto Bulgaria and Romania’s entry to the border-free Schengen zone, which the UK is not part of.

Clearly, Germany could be an ally for the UK in terms of instituting clearer and more transparent rules on EU wide migration and access to welfare which are necessary to restore public confidence in free movement, as we’ve argued in our report on the subject.

However, on the whole, the debate in Germany has been far more measured than in the UK, with substantially fewer scare-stories on the subject from the press and politicians. For example, the often sensationalist Bild ran a feature on Roma migration earlier this week which was relatively balanced, stating that “there has been no mass immigration” and that migrants tend to seek employment, not benefits.

And that's what UK politicians and media need to remember: the overwhelming evidence suggests EU migrants come to Britain to work, not take advantage of the system.

Tackling the slow, painful decline: A bad day of economic data for the eurozone

Some have said the worst of the eurozone crisis is over – this morning’s economic data did not provide much support to their argument.

 

Top of the list are the growth figures for the eurozone in Q4 2012 – as a whole the bloc contracted by a massive 0.6%. Maybe not a huge surprise but still worse than most expected. Furthermore, there were few glimmers of hope. 

As the graph above shows, Germany posted a contraction of 0.6%, Italy 0.9% and Portugal a massive 1.8% (more on this in a minute). France’s 0.3% contraction looked relatively mild, although it confirmed that the French economy saw zero growth in 2012 – it also put pay to any hopes of the French government achieving its growth projections for 2013 or its deficit target (see here for more on this). For all of these countries, this was the worst quarterly growth performance in almost four years (2009Q1).

The Italian statistics agency confirmed that growth for 2012 was -2.2%, a timely reminder of Italy’s real problem – an endemic and chronic lack of economic growth. The absence of any credible policy for correcting this in the current electoral campaign should be of grave concern to all of Europe.

Portugal was undoubtedly the stand out performer, but not in a good way. The 1.8% contraction in the final quarter brought the annual real terms contraction in 2012 to 3.2%. This result, along with the German contraction (which was put down to a collapse in European demand for German exports), highlights the substantial risk of expecting export lead recoveries to materialise when the entire eurozone is in a recession. The stumbling growth in the US and China at the end of 2012 likely created a further drag.

In fact, the only countries to provide any strongly positive data were the smaller central and eastern European economies – particularly Estonia, Latvia and Lithuania. Some would highlight that these are the countries that have already completed a significant round of structural reforms and internal devaluation. In any case, they are far from large enough to help pull the rest of the eurozone out of its current slump.

Meanwhile, the Greek statistics agency Elstat also released its figures for Greek unemployment in November 2012. Overall unemployment reached 27%. As we have noted many times before, this far outstrips the EU/IMF/ECB troika estimate for the end of 2012 which was 24.4% (this is even after it was revised upwards significantly in the IMF’s January report on Greece).

More worryingly though, youth unemployment has reached a whopping 61.7%. Think about that figure - it's absolutely extraordinary, especially when compared to the fact that it was only 28% three years ago. We can’t help but wonder how long such high levels of unemployment can be sustained before the political and economic impact becomes too heavy for the state to carry alone (i.e. before Greece demands further eurozone funding and concessions on its reform programme). Again, the risk is that the very fabric of Greek society could start disintegrating under such sustained pressure.

There has been plenty of optimism around the eurozone recently, some of it warranted and we should relish this. But this data should be a timely reminder of, arguably, the biggest challenge of them all for the eurozone: how to reverse the trend of slow, grinding decline.

If EU leaders thought for one minute that there were room for complacency, they can think again.

Another unwanted record in the eurozone...

Yesterday’s unemployment figures from Eurostat made a surprisingly big splash in the European press today. We say surprising since for anyone following the crisis this has been a longstanding and deeply concerning trend in the eurozone.

Eurozone unemployment reached a record high of 11.8% in November (up from 11.7% in October), while youth unemployment reached the staggering level of 24.4%, meaning almost a quarter of young people in the eurozone are out of work.

Looking deeper at the data, there are a few important points to consider:

The current trend runs counter to the majority of forecasts by the Commission and the IMF. We’ve discussed this before with regards to Greece, but it also holds for Spain, Portugal and many others. Although the pace of increases in unemployment is slowing, it has not yet stopped and with austerity set to continue across the eurozone it seems unlikely to do so at any point this year. Despite this, many of the forecasts show unemployment stabilising at or near current levels – this data highlights that this remains unrealistically optimistic.

There remains huge divergence between the stronger and weaker countries. With Austria posting unemployment of 4.5% compared to Spain’s 26.6%, the talk of the eurozone crisis being over seems rather pre-emptive. Fundamental divergences remain between the countries, with no clear mechanism for correcting or managing them yet being discussed at the highest level.

The increase in long term unemployment is becoming increasingly concerning. In the second quarter of 2012 it reached 5.2% in the eurozone, but topped 13% and 10% in Greece and Spain respectively. This has the ability to significantly harm the potential productivity of these economies and become a significant drag on (already low) economic growth. As with the wider figures it drives home the need for strong structural reforms, particularly to education and retraining programmes.

It’s also worth keeping in mind that this is happening at a time when growth is stagnating and public spending is falling sharply, meaning that the fall in standards of living for many people could be substantial – as we have pointed out before this has the potential to be a toxic mix in what is already a very politically divisive crisis.