Eurozone. EY Eurozone Forecast June 2014

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1 Eurozone EY Eurozone Forecast June 2014 Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Latvia Luxembourg Malta Netherlands Slovakia Slovenia Spain

2 Outlook for exits bailout, with moderate growth ahead Finland Estonia Latvia Ireland Netherlands Germany Belgium Luxembourg France Italy Austria Slovenia Slovakia Spain Greece Malta Cyprus Published in collaboration with

3 Highlights s economic fortunes continue to improve. After 3 consecutive years of recession, GDP is forecast to grow 1.1% in 2014 and financial market conditions have improved considerably. Yields on long-term Portuguese debt in June were trading close to record lows of 3.3%, with the Government having issued 750m in 10-year bonds in April for the first time since 2011 (and then a further 975m in June). As a result, has exited its 78b bailout without a precautionary credit line from the European Stability Mechanism (ESM). The economy has undergone a huge external adjustment, with a current account deficit of nearly 13% of GDP in 2008 turning into a small surplus in Labor market reforms and stagnant real wages are helping Portuguese firms to recover the competitiveness lost before the global crisis, which should support trade. Export volumes rose by more than 6% in 2013 and are expected to rise by 4.1% this year and then around 4% a year in GDP growth % GDP growth 1. 4% However, domestic demand will still face several constraints. For instance, the flash Q1 GDP estimate showed a fall of 0.7% from Q and, after a marked fall of around 2 percentage points in the unemployment rate in 2013, the labor market appears to have stagnated in recent months. Corporate indebtedness remains high and interest rates on new loans are among the highest in the periphery, despite easing in recent months. As such, we expect fixed investment to grow by about 2.5% a year in (meaning will underperform most of its Eurozone peers) and consumption to grow by only about 1% a year. The forecast is dominated by the downside risk of deflation. slipped into deflation in Q1, primarily because of a large amount of spare capacity in the economy, but also because of factors such as a stronger euro and lower energy prices. Although we expect to avoid falling into a deflationary spiral, this remains one of the main risks facing the economy Unemployment 15. 2% Consumer prices % EY Eurozone Forecast June

4 exits bailout, with moderate growth ahead The recovery continues According to the flash estimate, Portuguese GDP fell 0.7% on the quarter in Q1 2014, after 3 consecutive quarters of expansion. But it still grew 1.2% year-on-year. This result could have been affected by a drop in exports due to one-off factors, such as the temporary closure for maintenance of a refinery and a change in the production of a carmaker that can be easily reverted in the following quarters. Following 3 successive years of contraction, we now forecast that GDP will grow 1.1% this year. Net exports are still expected to contribute positively to growth, due to gains in competitiveness, coupled with a recovery in s main export markets, such as Spain, Germany and France, and a positive contribution from the tourism industry. However, domestic demand will remain subdued, as companies remain highly leveraged, credit conditions are tight and the labor market is very weak. and bailout exited without precautionary credit line Financial market conditions for have improved considerably. Yields on long-term Portuguese debt are currently trading close to 3.3% their lowest level since 2005 and more than 1,000 basis points lower than at the height of the crisis in Q And in April, the Government issued 750m in 10-year bonds directly to the market (i.e., without syndicated banks) for the first time since 2011, and there was a further 975m issue in June. As a result, has followed Ireland in making a clean exit from its three-year bailout, without the help of a precautionary credit line from official lenders. This outcome has been justified by the Government as a result of positive market conditions. But with the debt-to-gdp ratio still high, at about 130% of GDP, and a relatively wide fiscal deficit of over 4% of GDP, the country remains exposed to any rapid change in market sentiment. A precautionary program would have mitigated these risks and helped maintain the positive momentum in reforms. Meanwhile, fiscal consolidation has continued at a rapid pace, with the Government beating its 2013 deficit target of 5.5% of GDP, narrowing the gap to 4.5% (excluding one-off expenses). The Government is aiming for a fiscal deficit of 4% of GDP in 2014 and a primary surplus, with the bulk of fiscal adjustment coming from the spending side. The Constitutional Court has recently rejected some measures, such as Table 1 (annual percentage changes unless specified) GDP Private consumption Fixed investment Stockbuilding (% of GDP) Government consumption Exports of goods and services Imports of goods and services Consumer prices Unemployment rate (level) Current account balance (% of GDP) Government budget (% of GDP) Government debt (% of GDP) ECB main refinancing rate (%) Euro effective exchange rate (1995 = 100) Exchange rate (US$ per ) Source: Oxford Economics. 2 EY Eurozone Forecast June 2014

5 cuts to public sector pay, worth around 0.5% of GDP. In order to meet its deficit target for the year, the Government will have to find other savings, or possibly tax increases. The rating agencies have reacted to these encouraging developments, with Moody s upgrading s government bond rating to Ba2 (from Ba3) and signaling a possible further upgrade soon by placing it on positive watch. Meanwhile, Standard & Poor s has raised its outlook on s BB rating from negative to stable, while Fitch Ratings now has a positive outlook on its BB+ rating. An impressive external adjustment has made a major adjustment in its current account over the past few years: from a deficit of nearly 13% of GDP at the end of 2008 to a small surplus in This is a result of a contraction in domestic demand coupled with rising exports: in 2013, export volumes were 15% higher than in Moreover, this improvement in real net external trade has been magnified by a significant improvement in the terms of trade over the period, as growth in export prices at 5% far outpaced import price growth of 1.4%. Net exports will continue to contribute to growth in the next couple of years. Further gains in competitiveness as a result of ongoing labor market reforms and stagnant real wages, coupled with a gradual improvement in s main export markets, such as Spain, Germany and France as well as a positive contribution from tourism will support net external demand. Export volumes rose by more than 6% in 2013 and are expected to rise by 4.1% this year and then 3.5% 4% a year in But domestic demand is constrained by high unemployment After the marked fall last year from 17.5% in Q1 to 15.4% in Q4 the unemployment rate stabilized at just over 15% in Q1 this year, suggesting that the improvement in the labor market may have come to a halt. Indeed, we do not expect the jobless rate to fall significantly in the next few years and it is likely to remain above 15% for most of The increase in employment last year has been focused on the service sector, with few new jobs created in manufacturing, where raising productivity has been the priority. Figure 1 Corporate sector deleveraging Figure 2 Government balance and debt % of GDP Forecast % of GDP Government balance (left-hand side) % of GDP Forecast Eurozone Government debt (right-hand side) Source: Oxford Economics; Haver Analytics Source: Oxford Economics. 40 Table 2 Forecast for by sector (annual percentage changes in gross added value) GDP Manufacturing Agriculture Construction Utilities Trade Financial and business services Communications Non-market services Source: Oxford Economics. EY Eurozone Forecast June

6 exits bailout, with moderate growth ahead In the short term, the economic recovery will probably prove too modest to trigger significant improvements in hiring, with businesses likely to concentrate their efforts on restoring profit margins and deleveraging. Against the background of a weak labor market and continuing fiscal austerity, consumer spending is expected to grow by about 1% this year, leaving it around 9% below its 2010 peak. Moreover, the very high youth unemployment rate remains a key concern. At approximately 35%, this is one of the highest rates in the Eurozone. If not addressed, it may hamper activity over the medium term, reducing potential growth through declines in productivity and labor s contribution to the economy. tight credit conditions and on-going private deleveraging The situation facing the banking system remains very challenging. The 8 largest banks experienced a loss of around 2b last year and the non-performing loans ratio is over 12%. Credit to the private sector, both to non-financial corporations and households, has continued to fall and is not expected to increase for at least another year. Moreover, the European Central Bank s April bank lending survey suggests that credit standards and loans for corporates have improved only marginally on the quarter. Companies loan demand is expected to improve in the next three months, but it is very unlikely that this will translate into a rise in credit, as banks face a decline in profitability and a deterioration in asset quality with associated negative effects on credit conditions. Furthermore, credit conditions for companies remain challenging. Corporate interest rates, despite easing somewhat, are still the highest in the Eurozone after Greece. Therefore companies will have to deleverage in an environment of low profitability and high borrowing costs. Households have made good progress in deleveraging, with the outstanding debt-to-gdp ratio falling by more than nine percentage points from its peak, but corporate indebtedness remains high. The non-financial corporation debt-to-gdp ratio has fallen by only 4 percentage points from its peak and it is still around 155%. After a cumulative fall of 37% in , we expect fixed investment to grow by about 2.5% a year in , underperforming most Eurozone peers. With private investment growth so sluggish, the capital stock will only increase at a very subdued pace. If it is not addressed, this will reduce the economy s potential growth. Deflation risks continue to dominate was in deflation in Q1 this year. Consumer prices are expected to fall 0.1% this year and inflation will remain low in the years ahead. This is the result of weak domestic demand and substantial slack in the economy, with the output gap estimated at more than 7% this year. We expect to avoid falling into a deflationary spiral, even though the euro may remain stronger than previously expected and energy prices are likely to fall again in But the threat of deflation remains a major risk. At about 130% of GDP, the country has the 3rd highest public debt in the Eurozone, and it is expected to stay around this level until Because of this, deflation would mean that nominal GDP would stagnate or even shrink, leading to a rise in the debt-to-gdp ratio. A rising debt ratio would mean that remains vulnerable to swings in investor confidence, with high refinancing risks if interest rates start to rise earlier than expected. Figure 3 Typical interest rates on loans to businesses % 9 Figure 4 Real GDP growth % year 5 Forecast 8 3 Eurozone 7 Greece 6 Spain Germany 3 France Source: European Central Bank Source: Oxford Economics. 4 EY Eurozone Forecast June 2014

7 EY Forecasts in focus: macroeconomic data and analysis at your fingertips App EY Forecasts in focus gives you swift access to the data and analysis from EY s Eurozone Forecast and Rapid-Growth Markets Forecast on your tablet. Download the EY Forecasts in focus app at ey.com/eurozone. Compare economic indicators for the 18 Eurozone countries and 25 rapid-growth markets. Create tailored charts and tables for a broad range of economic indicators based on data from 2000 to the present and make forecasts up to Use the app to improve your own business planning and share customized information with clients. Web Highlights, data and other information from the EY Eurozone Forecast. Other EY publications Rapid-Growth Markets Forecast EY Eurozone Forecast: Outlook for financial services

8 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com EYGM Limited. All Rights Reserved. EYG no. AU2487 EMEIA Marketing Agency ED None In line with EY s commitment to minimize its impact on the environment, this document has been printed on paper with a high recycled content. About Oxford Economics Oxford Economics was founded in 1981 to provide independent forecasting and analysis tailored to the needs of economists and planners in government and business. It is now one of the world s leading providers of economic analysis, advice and models, with over 700 clients including international organizations, government departments and central banks around the world, and a large number of multinational blue-chip companies across the whole industrial spectrum. Oxford Economics commands a high degree of professional and technical expertise, both in its own staff of over 80 professional economists based in Oxford, London, Belfast, Paris, the UAE, Singapore, New York and Philadelphia, and through its close links with Oxford University and a range of partner institutions in Europe and the US. Oxford Economics services include forecasting for 200 countries, 100 sectors, and 3,000 cities and sub-regions in Europe and Asia; economic impact assessments; policy analysis; and work on the economics of energy and sustainability. The forecasts presented in this report are based on information obtained from public sources that we consider to be reliable but we assume no liability for their completeness or accuracy. The analysis presented in this report is for information purposes only and Oxford Economics does not warrant that its forecasts, projections, advice and/or recommendations will be accurate or achievable. Oxford Economics will not be liable for the contents of any of the foregoing or for the reliance by readers on any of the foregoing. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. ey.com

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