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Friday, February 22, 2008

February EU Commission Interim Forecast

The European Commission released a new interim forecast for the EU economies yesterday. Of particular note was the fact that the forecast significantly reduces the growth forecasts at the same time as sharply raising its inflation estimate The Commission said it was concerned that expectations of steadily rising prices were becoming entrenched in the 15-nation area.

My own opinion is that the current forecasts are far more realistic than than those issued in last November's autumn review. The outlook for growth in the eurozone as a whole for 2008 has been cut to 1.8 per cent from an earlier 2.2 per cent, but of more significance perhaps are the individual country estimates. Italy, which has been the eurozone’s slowest growing economy for the past 15 years, once again comes in at the bottom of the pile, with the Commission halving its growth forecast for this year to a mere 0.7 per cent. This follows a downward revision of the Italy growth forecast by the Bank of Italy (in the middle of January) to 1%, and a revision (earlier this month) by Confindustria, Italy's largest employers' lobby, who slashed their forecast also to 0.7%. Back at the start of January I said this on my Italy blog:

I personally will be very surprised if we still see calendar year 2008 anything like as high as 1.8%, but more to the point even 1.3% may be rather on the high side if we get a significant deterioration in the external environment, especially in Eastern Europe on which Italy is fairly dependent, and where the Italian banking sector has significant exposure. So that puts me much nearer to Pillona's "basement bargain" number of 0.5% than to any of the others. One of the reasons for my pessimism relates to my assessment of Italy's current trend growth rate, and to the level of fiscal and monetary tightening which may be operating on the economy even as it slows. During 2007 the Italian govenment has been running a fiscal deficit of comfortably below the 3% of GDP required by the EU commission. But since this fortunate situation was in part acheieved by the use of one off measures, and in part by the strong tax inflow from the above trend growth, the government will need to maintain a comparatively tight fiscal stance to keep things on course, and any attempt to further loosen may run into real problems with the EU commission and the credit rating agencies. And as I keep arguing, it is very hard to see an accomodative monetary posture from the ECB in the near future. The IMF in their October World Economic Outlook came in with a similar figure of 1.3% for 2008, the Economist Intelligence Unit is forecasting 1.7% in 2007 and 1.4 in 2008, and the latter 2008 figure was also endorsed by the EU commission in its November forecast.

As I indicate, my own view is well to the downside of all this. The only apparent bright spot on the horizon is employment, but I am dubious that in the context of Italy's ageing workforce this will work through as some are hoping, as I expain at some considerable length in this post here. My opinion is that Italy will enter recession at some point during 2008, and that we may well have 2 consecutive quarters of negative growth. The continuing high euro will maintain pressure on Italian exports, and high oil and food prices will maintain pressure on the inflation front, at least in the firts half of 2008. At the same time, and despite rumours that Romano Prodi's government is compemplating a large tax cutting package, I anticipate that the fiscal environment will remain tight. Italy's large (106% GDP) accumulated debt, and the vigilance from the gentlmen at Standard and Poor's and the other credit rating agencies more or less guarantee that.

I wouldn't say it exactly makes me happy to be being proved right here, but we do need some more realistic perspective on Italy's current growth potential from those responsible for forecasts and policy, and some more realistic appraisal (ie of population ageing) to try and understand why things are this way, rather than assuming it is all to do with some sort of congenital weakness on the part of the Italians.

The Commission lowered its country forecasts for Germany (to 1.6 per cent, from 2.1 per cent), and France (to 1.7 per cent, from 2.0 per cent), for the UK (to 1.7 per cent, from 2.2 per cent), and for Spain (to 2.7 per cent, from 3.0 per cent). Of these the French one looks to be the most realistic. The German forecast obviously contains strong downside risk, while the Spanish one seems to be talking about "another country" from the one I live in, when we come to look at the rate of the slowdown in the real economy (retail sales, industrial output, services etc), and add to this the growing tensions in the banking and financial sectors. I would stick my neck out and go for sub 1% growth in Spain this year, and feel reasonably comfortable with this.

Economy and Finance Commissioner Joaquim Almunia stressed the Commission’s view, which has been expressed many times since the financial market turbulence began last August, that the European economy would weather the storm because of its "sound fundamentals" – stable public finances, no huge current account deficits, relatively low unemployment and stronger international competitiveness. The strange thing is that he actually comes from Spain, a country which, it is true, has sound public finances at this point, but does have a huge (or whopping) current account deficit, which since last autumn it is having trouble financing since the monthly inflow of funds has dropped by around half, high (and growing) unemployment (around 10%) and poor producyivity growth (one of the worst in the EU) and hence comparatively weak international competitiveness. For these and many other reasons I suggest the 2.7% number is absolutely "pie in the sky", and may have a lot more to do with the fact that Spain is going to have elections in the middle of next month, with Mr Almunia's own party (PSOE) attempting to secure re-election.

On the inflation side the Commission raised its estimate for 2008 for the 27-nation EU to 2.9 per cent from the earlier 2.4 per cent, a revision which won't make the task of the ECB any easier when it comes to trying to use monetary policy to address the growth slowdown issues.

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