Concerning the Italian economy, now that the presidential election is behind us, attention has focused again on the risks associated with surging inflation and the upcoming start of the normalisation process of ECB monetary policy. 10-year Italian government bond yields have risen by nearly 50 basis points since early February, and they could reach the 2% threshold very soon.
The number of contactless card payments[1] increased by 61% in France between 2019 and 2020, according to the latest figures from the Bank for International Settlements (BIS). The Covid-19 pandemic has encouraged the increasing use of this payment method, which respects social distancing measures. In addition, in order to increase the number of transactions eligible for contactless payments, the cap was raised from EUR30 to EUR50 per payment. As a result, nearly 60% of payments at point of sell of less than EUR50 were made by contactless bank cards in 2020, worth a total of EUR71 billion (from EUR38 billion in 2019) according to Groupement des Cartes Bancaires[2]. As a result, the share of total digital payments[3] made by non-contactless bank cards fell sharply
The issue of de-industrialisation is often raised in France. Indeed, manufacturing now represents only 13% of GDP and 12% of payrolls (against 19% and 15% respectively in 2000). Capacity in French industry peaked in the early 2000s, before experiencing multiple setbacks; in parallel, industrial employment fell, and the trade deficit widened. Production capacity has reduced further in recent years and is nearly 20% lower than it was in the early 2000s. Although order books are overall the same as in 2018, production capacity is nearly 6% lower, which may explain why French industry is struggling to keep up with demand. A rebuilding of production capacity would be possible
Investor behaviour is strongly influenced by stylised facts, i.e. the historical relationship between economic variables and financial markets. When Bund yields increase, the spread of certain sovereign issuers tends to widen. This positive correlation will be perpetuated when enough investors believe that the historical relationship continues to hold. This was again illustrated in recent weeks by the significant widening of certain sovereign spreads in reaction to the rise in Bund yields. It creates a challenge for governments, due to higher borrowing costs, but also for the ECB, because of its influence on monetary transmission. This explains the ECB’s insistence on the flexibility offered by the PEPP reinvestments.
As shown on our Pulse, the sharp increase in inflation has continued in January, with the harmonised index of consumer prices (HICP) up 6.1% y/y in January. Although the details of last month’s inflation have not yet been revealed, energy prices should remain, unsurprisingly, the main driver of higher consumer prices. The energy element of the HICP recorded a jump of 40.2% y/y in December 2021, whilst the sector’s production prices nearly doubled (+95.9% y/y) between December 2020 and December 2021.
Based on Christine Lagarde’s latest press conference, it is clear that the ECB’s Governing Council view on the inflation outlook has evolved quite significantly. Since the December meeting, upside risks to inflation have increased, raising unanimous concern within the Council. Financial markets interpreted this as a signal that the first rate hike might come earlier than previously expected and bond yields moved significantly higher. The ECB’s forward guidance, which can also be considered as a description of its reaction function, suggests a rule-based approach to setting interest rates with clear conditions in terms of inflation outlook and recent price developments. In reality, a lot of judgment will be used as well
Against the background of economic recovery (real year-on-year GDP growth of 14.4% in Q2 2021, followed by 3.9% in Q3 and 4.6% in Q4 according to Eurostat’s preliminary estimate), outstanding bank loans to non-financial companies (NFCs) and households continued to accelerate in the eurozone between May and December 2021. Although substantial comparison effects mean that the figure is still in negative territory, its impulse (measuring the variation in annual growth in outstanding loans over one year) improved to -0.6% in December 2021.
Although Germany is not the eurozone country experiencing the highest inflation rate, the trend is nevertheless uncomfortable. Consumer prices posted another hefty rise in January (+5.1% y/y, harmonised index), although this was less than in December 2021 (+5.7%). The end of positive base effects – caused by the end of the VAT rate cut in place in the second half of 2020 – did not therefore result in a marked fall in inflation.
Usually close, French and German inflations, measured on a comparable basis by Eurostat’s harmonized index of consumer prices (HICP), have diverged sharply since the beginning of 2021, with inflation on the other side of the Rhine largely exceeding that in France. In November 2021, the gap reached +2.6 percentage points compared with an average of +0.2 pp since 1991. This difference is, for a part, due to a VAT effect: the decrease in the German rates in the second half of 2020 initially pulled down German inflation but the return to their previous level reverted that trend in 2021. In January 2022, with the end of this VAT effect, German inflation fell back quite significantly (to 5.1% y/y according to Eurostat’s flash estimate, from 5.7% in December) but is still very high
Economic newsflow was particularly rich last week. The first important items, looking in the rear-view mirror, were the first growth estimates for Q4 2021 in France, Germany and Spain. Performances were mixed, between the 0.7% q/q contraction in Germany, further strong growth of 2% q/q in Spain and, between these two, growth of 0.7% q/q in France.
French industry is benefitting from helpful conditions. Production has been boosted by order books that have filled up since spring 2021 and by growing capacity to meet this demand. The INSEE January 2022 business survey showed that inventories of finished products had increased to nearly 84% of their normal level, something not seen since mid-2020. This phenomenon is particularly visible in intermediate goods sectors. In chemicals, plastics and packaging (the ‘wood and paper’ segment), the percentage of current inventories in proportion of a normal level has bounced back even though it remains below this normal level. In metals and electrical equipment, very high inventory levels reflect very strong activity
The French economy seems to be getting off to a relatively good start in 2022, despite the introduction of tighter restrictions as a result of the Omicron wave. Positive momentum in the fourth quarter of 2021 – likely to be confirmed by GDP figures due on 28 January – has continued overall in the manufacturing and construction industries.
With less than two weeks to go before Italy’s presidential election – the first round of voting takes place on 24 January – a candidacy of the current Prime Minister, Mario Draghi, remains a distinct possibility. If Mr Draghi becomes Italy’s president, this would probably have repercussions for the current governing coalition, although it is not currently possible to predict what they might be. In the meantime, Covid-19 cases are continuing to surge, with around 170 000 new contaminations recorded in mid-January. This has prompted the government to make vaccinations compulsory for people aged over 50.
The fairly substantial upgrade to Spain’s Q3 GDP figures underlined again the problems that the Spanish statistical office (INE) is currently facing when collecting data. To recap, third-quarter growth was revised up from 2.0% q/q to 2.6% q/q and this follows a large downgrade for Q2, from 2.8% q/q to 1.1% q/q. Employment will remain in the spotlight in 2022, since it offers a parallel measurement of economic activity and one that is currently more accurate than GDP.
The indicators currently available for the end of last year suggest that Germany recorded weak growth at best in Q4 2021: a GDP contraction cannot be ruled out. Industrial orders remained at a relatively strong level, but production continued to be held back significantly by supply problems for certain components.
Euro notes and coins were introduced on 1 January 2022, and the euro is celebrating that 20th anniversary in fairly good shape. However, there are still many plans to improve and strengthen the European project and increase integration. This is shown by the topics on the agenda during the French presidency of the Council of the European Union over the next six months. Priorities will include reforming European fiscal rules, which will be a major topic of debate in 2022. Discussions are underway and decisions should be made this year. The challenge will be to avoid an anticlimax
Instead of drastically restricting conditions of activity, the government only made a few adjustments to their policy for combatting the pandemic: the state of emergency was extended for three months to 31 March 2022. Despite the resurging pandemic, business prospects are still looking upbeat this winter. PMI indices are holding at high levels, especially for the manufacturing sector. In November, the manufacturing PMI rose 1.7 points to a new high of 62.8, supported by the improvement of the employment and new orders components. The services PMI also improved, up 3.5 points to 55.9. The composite PMI for the past three months has held steady compared to three previous three months, as shown in the Pulse below.
Despite a substantial increase in new Covid-19 infections since the start of November, the infection rate is currently below those in France or Germany. Meanwhile, concerns about the health situation have had little effect on business confidence so far: the PMI Composite index improved in November (up 1.9 points to 58.3) thanks to better prospects in services. The positive trend in this sector can also be seen in the European Commission survey, which reveals levels of optimism not seen for twenty years. This said, household confidence has fallen back, mainly due to fears of rising consumer prices.
The resurgence of the Covid-19 pandemic and the emergence of the new Omicron variant make the ECB’s task even harder. Although growth should hold at a high level, it is expected to ease, and this trend could worsen, at least in the short term. Meanwhile inflation continues to soar, while becoming more broadbased, and the risk in the coming months is on the upside. Faced with greater uncertainty, the ECB is arguing in favour of patience and constancy while saying it is ready to act in any direction. According to our scenario, which is somewhat optimistic in terms of growth and calls for persistent inflation, the ECB would end its Pandemic Emergency Purchase Programme (PEPP) in March 2022 and begin raising its key deposit rate in mid-2023.
After strong growth in Q2 and Q3, the business climate deteriorated due to supply problems, the increase in prices and the surge in Covid-19 infections. Output is likely to stagnate around the turn of the year. The new government will put the emphasis on social and environmental policies, while fully respecting the fiscal framework, important for Germany. Private consumption will be the major engine for growth in 2022.
Factors hampering growth in the short term are gaining strength (supply chain disruptions, surging inflation, and the resurgence in the Covid-19 pandemic), but the resilience of business sentiment through November as well as numerous targeted measures to support household purchasing power help allay fears. In Q4 2021, we are forecasting growth of 0.6%, although the risk is on the downside. In full-year 2021, growth is expected to average 6.7%. In 2022, it will remain a robust 4.2%, bolstered by the accommodative policy mix, the unblocking of excess savings, the catching-up of the services sector as well as strong investment and restocking needs.
After a modest expansion in Q1 2021, real GDP rose by more than 2.5% q/q in both Q2 and in Q3. This recovery was widespread. In Q3, net exports added 0.5 percentage point to GDP growth thanks to a stronger rise in exports than imports. Thanks to the easing of social restrictions, consumption has further increased, while favourable financing conditions and fiscal incentives have supported investment. During the summer, the recovery expanded to the services sector, which benefitted from higher tourist receipts. Manufacturing production has recovered entirely from the 2020 decline, ending up 2% higher than in Q4 2019. Labour market conditions are not as good as the recovery would suggest.
Despite a rather weak recovery in GDP, the Spanish economy has been much more resilient on the labour market front in 2021. Employment (November) and the participation rate (Q3) are at record levels. Inflation will be one of the biggest obstacles in 2022, the increase in production prices having accelerated markedly this autumn. Support for growth will remain a government priority in 2022. The country will benefit from a larger transfer of European funds that will help finance a record budget of EUR196 billion. The reduction in the government deficit will be again pushed into the background, the authorities mainly betting on economic growth to reduce the deficit-to-GDP ratio.
Q3 Belgian GDP growth came in at 2% q/q, which is well above consensus. GDP thus exceeded its pre-Covid level for the first time since the start of the pandemic. For this year, we estimate the growth rate to reach 6.1% in annual average terms, with a slower but still above-potential growth rate of 3.1% expected for next year. As it stands, the Belgian economy looks to have avoided additional scarring; however, with elevated public debt levels entering the limelight once again, the De Croo government has its work cut out.
Once Covid-related restrictions are lifted, the economy is projected to rebound strongly in 2022, driven initially by household consumption. Next year, the fiscal stance is likely to tighten because of the gradual withdrawal of the special support measures. A major political risk is the possible falling apart of coalition between the conservative ÖVP and the Greens.
