Euro Area: The Real Economy Hasn’t Shown Up For The Party

The euro area recession deepened at the end of last year, and the beginning of 2013 has been disappointingly weak as well. Headwinds are fading but the outlook has worsened, especially in Italy and France.

The strengthening of growth abroad will be an essential driver of the euro area recovery. The very positive market sentiment should gradually begin to spill over to the real economy.

The euro area is expected to return to positive growth in Q2. Due to a substantial negative carry over, this year's GDP is projected to be 0.4% lower than last year's, while we forecast 1.2% GDP growth in 2014.

France could be the next 'sick man of Europe'. French PMIs signal a deepening recession. French reforms tend not to be supportive for growth and the housing market looks stressed.

The ECB is likely to keep interest rates on hold until 2015. A period of weak data will not result in interest rate cuts, as long as the ECB believes the recovery path is broadly intact.

The real economy hasn’t joined the party
The financial markets have celebrated the ECB’s OMT programme since it was announced last summer, but the real economy in the euro area never showed up for the party. Instead, the recession deepened more than expected late last year. GDP declined as much as 0.6% q/q in the fourth quarter, as households continued to cut down on consumption and companies cut investments as well as inventories further. There are many reasons for the real economy’s reluctance: the prolonged negotiations on a deal for Greece created a sense of uncertainty in October and November, and the US fiscal cliff at the end of the year seems to have caused companies to delay investment decisions until early this year. Fiscal and credit tightening also continued to weigh on the economy. Net exports had almost no growth impact as imports and exports fell by an almost equal amount.

The worse-than-expected fourth quarter in 2012 is the main reason for the downward revision of our forecast for 2013 from 0.3% to -0.4% GDP growth. The negative carry over amounts to as much as -0.5% of GDP. The beginning of 2013 has been disappointingly weak as well. Industrial production declined further in January, car sales hit a new record low and unemployment rose to 11.9%. Based on this we no longer expect that the euro area will be able to deliver positive growth in the first quarter of the year.

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