Economic recovery and sources of political instability

Politics has once again taken centre stage both sides of the Atlantic. In the USA, non-essential discretional payments have been suspended (approximately one sixth of federal spending) because Democrats and Republicans have been unable to reach an agreement about the budget. However, the impact on economic activity is thought to be moderate provided the situation is resolved soon. In this respect, both market pressure and the political leaders' own sense of responsibility suggest that an agreement will be reached before the debt ceiling is reached (predicted for 17 October). Politics has also come to the fore on the other side of the Atlantic. In Italy, another episode of disagreement between the different parties forming the governing coalition has acted as a reminder that the support enjoyed by the current president of the republic is extremely fragile and he will find it difficult to carry out the agenda of reforms the country requires. In Germany, however, Angela Merkel achieved a resounding victory in the general elections. The endorsement this supposes for how she has managed the sovereign debt crisis will make her even stronger to continue leading the process of re-establishing European institutions at a slow but steady pace.

The central banks are still prepared to support the recovery. In spite of these political upsets, 3Q economic indicators for the main developed economies still point to an improvement in activity. Nonetheless, the Fed, at
its September meeting, decided to delay the withdrawal of stimuli (tapering), preferring to wait for the economic recovery to firm up. This decision surprised most analysts and the markets did not hesitate to respond: yields on US government bonds fell, stock markets saw sharp gains and the dollar lost value against other currencies such as the euro and those of emerging countries. In the euro area, interest rates fell for both the monetary market and sovereign debt. The ECB believes that a hike in interest rates could derail the fragile recovery and has indicated that it is ready to hold another long-term liquidity auction should interbank market rates pick up further, either due to the Fed's tapering or to the imminent return of the 3-year financing operations from December 2011 and February 2012.

Tensions are easing in the emerging countries. After August's financial turbulences, the Fed's decision to postpone tapering, together with the progressive normalisation of capital flows, have helped to calm the financial and foreign exchange markets of the emerging economies: the depreciation of their currencies has moderated, capital outflows have slowed down and stock markets are on the up. But once this phase comes to an end, we must not forget that the macroeconomic imbalances still remain that had aggravated tensions in the five most vulnerable countries (Brazil, India, Indonesia, Turkey and South Africa). This means it is necessary to resolve the underlying problems by implementing reforms. For the time being, the good news provided by China and Brazil's activity indicators has helped to create a more optimistic view of the growth prospects for emerging countries.

The euro area is still growing, albeit moderately, supported by the advance towards banking union. Leading indicators in 3Q confirm the upward trend of the last few months and point to the GDP growth that began in 2Q consolidating. Nonetheless, growth will continue to be slight while public and private balance sheets are still being adjusted. To reduce the downside risks, it is vital to strengthen the governance of European institutions. In this respect, the European Parliament approved the single banking supervisor, which gives the authority to supervise all banks in the euro area to the European Central Bank. This represents another step forward for banking union, a key element in laying the foundations for a solid economic union capable of successfully tackling the next crisis.

The Spanish economy may post its first positive growth figures in 3Q 2013 after nine quarters of contraction. The latest activity indicators have not disappointed and the figures are compatible with a very moderate expansion
in GDP in 3Q 2013. The foreign sector is still the driving force behind the recovery but a smaller decline in domestic demand is key to posting the first positive quarter-on-quarter growth rate since 1Q 2011. In any case, the exit from the recession is expected to be very gradual. The troika, concluding its fourth mission to inspect compliance with Spain's bank bail-out conditions, recommends reinforcing banks' balance sheets even further to ensure that these, in turn, can improve their credit capacity. It also notes the vital importance in continuing with reforms and warns that it is essential to meet the target deficits in order to consolidate the improvement seen in market confidence. These recommendations will doubtlessly help to establish sustainable growth in the long term.