The European Economy. Simon Barry Chief Economist Republic of Ireland. December 2012

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1 The European Economy Simon Barry Chief Economist Republic of Ireland December 212

2 Euro area economy now back in recession as GDP contracts in 3 of the past 4 quarters Euro Area Real GDP Growth, % Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Mar-11 Sep-11 Mar-12 Sep-12 q/q (lhs) y/y Slide 2

3 exports have continued to provide a badly-needed source of growth, though trends have softened this year Euro Area Export Growth, % Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 q/q (lhs) y/y Slide 3

4 the weakness has been concentrated in domestic demand which has been contracting for over 15 months now Euro Area Domestic Demand Growth, % Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Mar-11 Sep-11 Mar-12 Sep-12 q/q (lhs) y/y Slide 4

5 investment trends have been particularly weak, reflecting concerns about future demand Euro Area Investment Growth, % Euro Area GDP Growth, y/y % Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 q/q (lhs) y/y Mar-8 Sep-8 Mar-9 Sep-9 Mar-1 Sep-1 Mar-11 Sep-11 Mar-12 Sep-12 GDP Investment Exports Slide 5

6 and very high levels of uncertainty, both in Europe, and in the US 25 European & US Policy-related Economic Uncertainty Index Nov-97 Nov-98 Nov-99 Nov- Nov-1 Nov-2 Nov-3 Nov-4 Nov-5 Nov-6 Nov-7 Nov-8 Nov-9 Nov-1 Nov-11 Nov-12 Source: policyuncertainty.com European US Slide 6

7 Euro area woes have contaminated the UK, which itself has double-dipped this year UK Goods Exports, y/y% (3mth avg) (Ex oil and erratics) Oct-8 Jan-9 Apr-9 Jul-9 Oct-9 Jan-1 Apr-1 Jul-1 Oct-1 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Non EU EU UK Real GDP Growth, % Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 q/q (lhs) y/y Slide

8 and where the consumer has also faced a nasty real income squeeze, though this is beginning to ease UK CPI Inflation, y/y% UK Consumer Spending Growth, % Nov-98 Nov-99 Nov- Nov-1 Nov-2 Nov-3 Nov-4 Nov-5 Nov-6 Nov-7 Nov-8 Nov-9 Nov-1 Nov-11 Nov-12 CPI Target Mar-8 Jun-8 Sep-8 Dec-8 Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 q/q (lhs) y/y Slide

9 Overall, euro area labour market conditions continue to deteriorate, in marked contrast to the trends elsewhere 13 Unemployment Rates, % of labour force Nov-2 Nov-3 Nov-4 Nov-5 Nov-6 Nov-7 Nov-8 Nov-9 Nov-1 Nov-11 Nov-12 Euro Zone US UK Slide 9

10 The latest business survey indicators indicate growth momentum remains very poor in Q4 Euro Zone Composite PMI vs GDP q/q % Dec-5 Jun-6 Dec-6 Jun-7 Dec-7 Jun-8 Dec-8 Jun-9 Dec-9 Jun-1 Dec-1 Jun-11 Dec-11 Jun-12 Dec-12 Comp PMI GDP q/q (RHS) Slide 1

11 Euro area fiscal crisis? What crisis?! Deficit Levels 212, % of GDP Debt Levels 212, % of GDP Source: IMF Euro Area UK US Source: IMF Euro Area UK US Slide 11

12 Chronic competitiveness problems? Really? Current Account Balances 212, % of GDP Source: IMF Euro Area UK US Slide 12

13 The pan-euro area averages mask the real story, which is one of enormous & highly problematic divergence in fiscal performance Euro Area Budget Balances 212, % of GDP Source: IMF, Dept of Finance Euro Area Debt Levels 212, % of GDP Germany Finland Estonia Luxembourg Malta Italy Austria Belgium Netherlands Slovenia France Cyprus Slovak Republic Portugal Spain Greece Ireland Greece Italy Portugal Ireland Belgium Spain France Cyprus Germany Austria Malta Netherlands Slovenia Finland Slovak Republic Luxembourg Estonia Source: IMF, Dept of Finance Slide 13

14 in external balance positions (where high deficits are symptomatic of large, cumulative declines in competitiveness) Euro Area Current Account Balances 212, % of GDP Source: IMF, Dept of Finance Netherlands Luxembourg Germany Austria Ireland Slovenia Slovak Republic Estonia Belgium Malta Italy Finland France Spain Portugal Cyprus Greece Slide 14

15 Greece and in growth performance Euro Area 212 Real GDP, y/y% Slide 15 Cyprus Portugal Source: Consensus Economics, European Commission, UB Slovakia Estonia Malta Germany Austria Ireland Luxembourg France Finland Belgium Netherlands EURO AREA Spain Slovenia Italy

16 Decisive policy response is key to breaking the resulting negative feedback loops (including between sovereigns and banks) Weak Balance Sheets Weak Growth Weaker Growth Weak Politics Weak Financial Conditions Weak Confidence Slide 16

17 Mr Draghi (3 rate cuts, 2 LTROs, the OMT programme, and more..) deserves much credit ECB Refi Rate % Source: Bloomberg 8-Yr Govt Bond Yields Mar-1 Jun-1 Sep-1 Dec-1 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec Jan-99 Jan- Jan-1 Jan-2 Jan-3 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 Source: Bloomberg Slide 17

18 The central banks have pulled out all the stops, and have succeeded in stabilising financial conditions, even in Europe Bloomberg Financial Conditions Index Jun-7 May-8 Apr-9 Mar-1 Feb-11 Jan-12 Dec-12 Euro Area US Slide 18

19 where break-up fears have receded considerably Slide 19

20 But much more needs to be done to complete the Union ; it s time for the politicians to step up Key elements of euro area reform agenda Banking union Fiscal integration Rebalancing Public finances Private (financial and non financial) sector deleveraging competitiveness Stronger focus on growth-promoting policies Political legitimacy Institutional reform Track record to date: Policy response has generally been reactive, slow in coming & behind the curve Action & decisions have tended to come only under major market pressure (e.g. June summit) But: important progress has been made (e.g. fiscal treaty, steps to Single Bank Supervisor) And solidarity (albeit conditional, sometimes begrudging) has been an important feature of the policy approach (e.g. improved terms for programme countries, recent concessions for Greece); there is a strong mutual self-interest in avoiding destructive break-up scenarios So base case is for further gradual progress towards deeper integration Should result in improved performance and, over time, reduced uncertainty But the process remains subject to important economic and political risks which mean the journey is likely to bumpy, with associated bouts of volatility Slide 2

21 some elements of the strategy look flawed; the surplus (i.e. excess savings) countries must also contribute meaningfully to the adjustment effort Euro Zone Current Account Balances, USD Source: IMF; graph shows total balances of the 5 largest country surpluses and the 6 largest deficits Surplus Deficit Slide 21

22 In the meantime, the ECB remains a key institutional actor; watch out for more from Draghi in Mkt Interest Rate Expectations: 3-Month Euribor 5 4 Avg Dec-98 Dec-99 Dec- Dec-1 Dec-2 Dec-3 Dec-4 Dec-5 Dec-6 Dec-7 Dec-8 Dec-9 Dec-1 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Actual 29/12/211 Current Slide 22

23 so there may be some (modest) downside for the euro in the months ahead Oct-1 Dec-1 Eur/USD vs Interest Rate Differentials Mar-11 May-11 Aug-11 Nov-11 Jan-12 Apr-12 Jul-12 Sep-12 Dec Oct-1 Dec-1 Eur/Stg versus Interest Rate Differentials Mar-11 May-11 Aug-11 Nov-11 Jan-12 Apr-12 Jul-12 Sep-12 Dec yr Swap Eur/USD (RHS) 5yr Swap Eur GBP Slide 23

24 FX markets can be very volatile & a source of major headaches, so active risk management of currency exposures is vital Past 2 years High Low Eur/USD, $ Eur/Stg, Slide 24

25 A note of caution on interest rates: lower for longer record lows forever FOMC September '12 Projections for Fed Funds over the Longer Term Number of members (vertical) vs. FF projection (horiz) Slide 25

26 Base case is for weak, but at least improving European growth performance in 213/14 as headwinds and uncertainties fade Source: Bloomberg, Consensus Economics Annual GDP Growth, US EZ UK Slide 26

27 but downside risks continue to prevail 3. % Evolution of GDP forecasts for Source: Consensus Economics Horizontal axis = date of forecast. Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 US UK EZ Slide 27

28 PMIs indicate Ireland s traded sectors are outperforming the wider euro zone, not just other vulnerable countries 65 Manufacturing PMIs: Ireland vs. IT/Gre/Sp 65 Composite* PMIs: Ireland vs. Eurozone Source: Markit 35 3 Source: Markit, * Manufacturing and Services, 3m avg Ireland Italy Greece Spain EZ Ireland Slide 28

29 The private sector, not fiscal policy, holds the key to Irish recovery; the latest jobs trends offer much encouragement 5 Breakdown of Employment, annual change (s) Source: CSO, UB estimates Mar-9 Jun-9 Sep-9 Dec-9 Mar-1 Jun-1 Sep-1 Dec-1 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Private Employees Public Employees Self Emp Slide 29

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Euro-QE at the end of the road for now

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