The drop in inflation in Spain has provided no respite for the coalition in power. The Socialist Party’s losses in the regional and local elections on 28 May to the People’s Party, led Prime Minister Pedro Sanchez to announce a snap general election on 23 July, five months before the originally scheduled date. Despite a still dynamic labour market, the drop in purchasing power and the housing crisis are penalising the party in power, which has fallen even further behind in the polls this spring. The property market is showing signs of a limited correction for the time being, but the continuation of monetary tightening and the resulting hike in lending rates are likely to accentuate this downturn.
At the start of this year, Belgian GDP growth remained at above-average levels. Inflation is currently slowing down alongside the cooling of the labour market. Rising interest rates have started to bite, as real estate spending is already declining, with firm capex to follow suit. A (brief) recession towards the end of the year remains possible but unlikely. Even if it does materialise, a debt-constrained government won’t be of much help, however.
While it might have been hoped that the current drop in inflation would provide a stronger boost to household confidence, this, and consequently consumption, remains constrained. This is due to the impact of rising interest rates on purchasing intentions in both France and Germany.
Initially estimated at +0.1% q/q, growth in the eurozone in Q1 2023 is now slightly negative, at -0.1% (after a similar drop in Q4 2022). This downward revision was driven by that of German growth. The succession of two quarters of decline in GDP defines a “technical” recession, which it is at this stage: the contraction in GDP is small and it is not broad-based to all growth components neither to all the Member States.
Business climate indicators in Germany have deteriorated in recent months, including the IFO survey (91.7 in May, 5 points below its long-term average, compared to 93.4 in April) or the ZEW index. The latter recovered slightly in June (-8.5 compared to -10.7 in May) but remained very negative and continued to deteriorate in most industrial sectors, as a result of a fall in demand (the current situation index fell at the same time from -34.8 to -56.5 between May and June).
French economic indicators point to a slowdown in growth. INSEE’s business climate in the manufacturing industry has deteriorated. It stands at 101 in June, below its average level during the Q1 (104) and was in May (99) below its long-term average (100) as well as wholesale trade (94) and non-automotive retail trade (94). In particular, the balance of opinion on order books in the manufacturing sector was in June (-17) below its levels observed in December (-15) and March (-13).
The Italian economy surprised positively in the first quarter of 2023, with real GDP growing by 0.6% q/q. However, we expect this good performance to be followed by a slowdown in the second quarter and then a one-off contraction in the third quarter.
Despite the support of tourism, which has been at levels close to those of 2019 since the beginning of the year, the effects of the rise in interest rates and the drop in household purchasing power on the Spanish economy should worsen over the course of the year.
The transmission of higher interbank rates to bank deposit rates is still limited in Spain.
The German economy experienced a recession during Q4 2022 and Q1 2023. Even though consumer spending has significantly contributed to this downturn, growth has been underperforming in Germany for over five years, largely driven by the underperformance of its manufacturing sector. Industry has been facing stronger constraints than elsewhere in Europe, and its size has decreased, which is a relatively new phenomenon in recent times in Germany. The country is still going through this tough patch for industry, which could cause German growth to fall again during the second half of the year.
The most comprehensive and well-documented assessment to date of the cost of France's ecological transition has just been published by the France Stratégie institute, in a widely commented report. By 2030, meeting our climate commitments - which involve a 55% reduction in greenhouse gas (GHG) emissions compared to 1990 levels - will require almost EUR 70 billion or 2.5 points of GDP in additional annual expenditure.
The analysis of the cyclical environment tends to focus on the change in the level of economic variables (growth, inflation), rather than on the level (activity, prices) itself. However, both matter. The recent decline in energy price inflation is good news but the price level remains well above that recorded at the start of last year. In the manufacturing and construction sectors, the assured production based on the level of order books remains very high. This might explain what hiring plans remain elevated. However, the order intake has been slowing. Historically, such a development has been followed by a reduction in the length of the assured production
Dutch GDP contracted by 0.7% q/q in Q1 2023, after +0.4% q/q in Q4 2022 (revised by 0.2 percentage points to the downside). There are several drivers to this contraction observed in Q1.
According to the latest data, inflation in both the euro area and the US is mainly driven by its core component and thus, at first glance, by demand. Supply factors are also at work through the spillover effects of the shock on energy and commodity prices and food inflation. These first-round effects show first signs of fading, which should pull inflation down more sharply in the coming months. Wage dynamics are closely monitored given their inflationary nature, which is modest but persistent, justifying the monetary response.
Non-financial companies’ profit margins increased in the first quarter of 2023 to reach 32.3%, up from 31.9% in the fourth quarter of 2022. French companies continue to benefit from increased pricing power to settle their sale prices.
Based on the PMI data and the European Commission business surveys, it seems that in the Eurozone, industry is clearly slowing down, demand is softening and labour market bottlenecks have eased somewhat. In combination with input prices that are down, this should lead to an easing of output price inflation. In services, the picture is different. Hiring difficulties remain a big constraint on activity, momentum in terms of activity and orders has improved. Input price and output price inflation has eased only slightly. Such a dichotomy complicates the task of the ECB: ongoing strength in services would imply that past rate hikes didn’t yet have a significant impact and would justify more tightening, but this would only make things worse for the industrial sector
Eurozone growth in the first quarter of 2023 was +0.1% q/q according to the data available at the time of writing. This is below our forecast (+0.3% q/q), and therefore rather disappointing, even if it surprises favourably compared to our nowcast estimate (-0.0%). This low growth also puts into perspective the perceived resilience coming from most survey and activity data during the first quarter.
Industrial activity and new industrial orders experienced sizeable variability in Q1, with a strong rebound in January-February followed by a sharp drop in March. Overall, new orders remained stable during the first quarter (q/q). The IFO survey has even deteriorated in May, and the ZEW index has returned to negative territory.
The business climate surveys from the French National Institute of Statistics and Economic Studies (INSEE) deteriorated in April and May, raising fears that the upturn in business activity seen during the first quarter was temporary to a certain extent.
The preliminary estimate of Italian economic growth in the first quarter was a positive surprise, with real GDP rebounding by 0.5% q/q. However, we anticipate a slowdown in activity in Q2, before a contraction in Q3. At 0.9% in 2023, Italian GDP growth would still be above that of the eurozone as a whole.
Spanish growth strengthened slightly in Q1 2023, to +0.5% q/q, according to preliminary figures from INE. However, this acceleration, supported by investment and external demand, did not allow real GDP to cross the pre-Covid threshold. It still showed a small deficit of 0.2% compared to Q4 2019.
Continuing the downturn observed in April, INSEE’s business climate indicator fell again in May to 100, the lowest since April 2021. The downturn is widespread and particularly noteworthy regarding the manufacturing sector, where the confidence index even fell to 99, below its long-term average (100) for the first time since March 2021. At the same time, inflationary pressures are continuing to ease.
The French labour market continues to be surprisingly strong with 42,000 net job creations in the first quarter of 2023 according to the INSEE, even though the economy has shown numerous signs of cooling off for more than a year. There is nothing abnormal about the labour market’s resilience, which has still benefited from post-Covid catching-up effects, notably in market services. Yet several driving forces have seized up, especially in construction, and the labour market could begin to deteriorate.
Earlier this week, Hungary published its GDP data for the first quarter. It fell by 0.2 % compared with the previous quarter after -0.6% in Q4 and -0.8% in Q3. This is not a major surprise given that high frequency indicators such as retail sales and industrial production were already pointing to a weakening in economic activity. Elsewhere, in the region, GDP growth was also soft though we observe a better performance in Czech Republic Romania and Poland. The Hungarian economy is experiencing numerous challenges while some positive developments provide some relief.
How much and how quickly inflation will decline in the Eurozone is of key importance for the ECB, households, firms and financial markets. There is concern that disinflation might be slower than expected until now. The latest ECB survey of professional forecasters shows an increase in the number of participants expecting inflation to remain elevated. Inflation persistence can have different sources: a succession of shocks, staggered price adjustment by firms, price and wage increases that try to compensate for the past increase in costs and the loss of purchasing power, evolving inflation expectations. Going forward, the tightness of the labour market, the strength of wage developments and the momentum in service price inflation are key factors to monitor.
