More pessimism than weakness

Growth is still weak in the euro area but is gradually building up steam. The IMF has lowered its forecasts for the main economies of the euro area except Spain and predicts a slow recovery at differing speeds. Germany and Spain will grow at a faster rate than France and Italy, the latter even falling into recession in 2014. Given this situation of weak growth, small shocks are felt more keenly here than in countries with higher growth rates where a similar reduction in growth is less problematic. Perhaps this is why the IMF has accompanied its downward revision of forecasts for the euro area with a very pessimistic discourse although its central scenario is one of gradual recovery. Broadly speaking, the deceleration in growth occurring over the last few quarters is the result of the slowdown in trade at a global level and of the reappearance on the scene of latent geopolitical conflicts. Both are temporary factors and should therefore not sully the recovery in the medium term.

The underlying trends differ greatly between countries. This deterioration in growth prospects has highlighted the need to take measures to boost growth in the euro area. However, the differences between countries are very notable and, consequently, although a high level of coordination is desirable at a European level, each case needs to be treated separately. A brief review of growth per capita over the last few years is highly illustrative. Germany and France experienced similar trends up to the global financial crisis but their paths have diverged since then. Germany has benefitted from the structural reforms carried out at the beginning of the millennium while the lack of dynamism suffered by France's economy has become evident. The deeply-rooted ills of the Italian economy have been known for years and pose a real challenge for Mateo Renzi's government. Lastly, Spain grew continuously up to 2008 but lacked solid growth and slumped from then on. However, the correction of its main macroeconomic imbalances and far-reaching structural reforms carried out are helping the country to enjoy a recovery which, for the present, is surprisingly vigorous. The challenge for Spain will be to ensure its growth is balanced and sustainable in the longer term.

Pressure is rising for France and Italy to take measures to boost their long-term growth capacity. The vulnerability demonstrated by France and Italy over the last few months has once again highlighted deficiencies in both economies. Given this situation, an intense and sometimes tense debate has broken out at a European level regarding which measures should be adopted. It finally seems that a balance has been struck between slightly less fiscal adjustment than initially planned in exchange for a stronger agenda of reforms. The reduction in the structural deficit forecast for these countries is 0.5 pps for France and 0.3 pps for Italy, an adjustment which, in principle, Brussels has accepted in spite of the fact that the deficit targets set for 2015 will not be met (4.1% compared with 3.0% in France and 2.9% compared with 2.2% in Italy). With regard to the reforms to be carried out, a change in attitude can now be glimpsed. In addition to its «crédit d'impôt pour la compétitivité et l'emploi» plan and the recent Responsibility and Solidarity Pact, France has added measures such as reducing taxes in regulated sectors and bureaucracy when starting up a company. Progress is being made in Italy to pass labour reform that reduces the substantial rigidity that often prevents firms from taking on new staff. All these reforms should boost the competitiveness of firms and potential growth, although they are tentative in comparison with those undertaken by several peripheral countries and need to go a lot further, in particular in the labour market.

Most activity indicators improved slightly in October. In the short term, the poor trend for Q3 indicators does not necessarily mean a third recession and signs of slight improvement can actually be seen for Q4. Both the PMI and the economic sentiment index in October point to slightly positive growth, helping to allay fears of a third recession. However, the still tenuous growth in the euro area is forcing many firms to reduce their margins. By country, of note is the slight improvement in both indicators in Germany where the PMI has been expansionary for the last 18 months although it is still lower than at the beginning of the year. France and Italy, however, remain in the recessionary zone.

Demand indicators are also improving slightly. August's retail sales performed better than in the first few months of the year although they are still at a low level. The consumer confidence index also improved in October after several months of decline. However, as with the business indicators, the disparity between countries is notable. Germany stands out on the positive side while France and Italy take centre stage on the negative.

The slow improvement in the labour market is limiting the capacity for domestic demand to recover. The euro area's unemployment rate held steady at 11.5% in September 2014, lower than the figure of 12.0% recorded a year earlier but unchanged from the previous two months. Moreover, unemployment expectations do not point to any notable improvement in the short term, although they have improved slightly. By country, while Germany's unemployment rate is still at an all-time low and the periphery countries are seeing improvements, neither France nor Italy are managing to recover. At a European level the level of unemployment among young people aged 16 to 25 is still the greatest concern, this being 21.6%, with almost five million young people in the euro area unemployed. The problem is particularly pressing in Spain (53.7%), Greece (50.7%), Italy (42.9%) and France (24.4%). Acceleration in the structural reforms for the labour markets, as well as good use of the funds available from programmes such as the Young Employment initiative and the European Social Fund should help to improve the chances of young people in the job market.

Inflation, reflecting economic activity, will gradually change its tune. The general inflation rate rose by 0.1 pp in September to 0.4% year-on-year while core inflation held steady at 0.8%. This rise in general inflation is due to the most volatile components, in particular higher food prices and the moderation in the fall of energy prices. Over the coming months, as fears of a third recession disappear, domestic demand picks up and the euro continues to depreciate, inflation should embark on a clear upward trend. In any case we do not expect any sharp rise as the elements pushing up inflation are weak and, furthermore, the fall in oil prices will help to push it back down.

The foreign sector will become more important in the coming quarters. Both exports of goods and imports of goods were down in August compared to the previous month (0.9% and 3.1% respectively) although showing an improvement over the first half of the year. The weakness seen since the beginning of the year is due to temporary factors such as the slowdown in trade at a global level and the emergence of geopolitical conflicts in Ukraine and the Middle East. Consequently, as these factors lose their effect, the foreign sector should gradually regain the importance it has enjoyed over the last few years. The depreciation of the euro and the fall in oil prices are additional factors that should improve the competitive position of Europe's economy and thereby boost the recovery in exports in the short and medium term.

Bank credit will also help to support the recovery. The criteria applied to grant loans continued to ease in 2014 Q3, particularly for large firms. The bank lending survey carried out by the ECB also showed that, in loans to households, the net percentage of banks relaxing conditions to purchase housing increased in Q3, albeit at a slower rate than in Q2. Also of note are the easier conditions for granting consumer loans, a factor that should help to revive consumption in the euro area. This improvement in banks' credit capacity is closely linked to the completion of the asset quality review (AQR) and stress tests carried out by the ECB. As mentioned in the Focus «European banks are more resilient to weather future crises», these tests have been successfully passed by the sector as a whole, reinforcing its credibility.