Spain on the way back … to stagnation

July 30, 2013

Spain heads the rest of the euro zone pack with second quarter GDP figures at a time when we’re seeing glimmers of hope, with surveys suggesting the currency area could resume growth in the third quarter.

The Bank of Spain has forecast a 0.1 percent drop in GDP from the previous three months. It is usually close to the truth which supports the government’s claim that the economy is close to emerging from recession.

Last week, the Spanish unemployment rate fell for the first time in two years, although at 26 percent of the workforce it remains alarmingly high, and PMI readings have begun to pick up.

Other euro zone GDP reports are still a couple of weeks away.

Even if the economy only contracts by 0.1 percent, having shrunk by 0.5 percent in the first quarter, economists have warned that while the slump may be coming to an end, sustainable growth is a long way off. The central bank expects output to be flat over the next 12 months and says the economy remained very sensitive to adverse shocks, particularly on the fiscal side.

Nonetheless, even stagnation would be an improvement and there are signs of life elsewhere too. Italian consumer morale is picking up and retail sales have risen for the first time in 14 months. French consumer spending may be recovering (latest figures on that are due Thursday). But for the most parlously placed – Greece and Portugal – there is no such luck.

It might be that Germany does not race away from the pack this time. Both the government and Bundesbank are forecasting a robust second quarter but then something of a relapse in the third. German inflation figures are due later and will go some way to show how much leeway the European Central Bank has to loosen policy further. The forecast is for the rate to edge down to 1.7 percent, somewhat below the target of close to but below two percent. We also get euro zone business and consumer sentiment readings.

It wouldn’t be the euro zone if there weren’t threats lurking. Today’s comes in the form of an Italian Supreme Court ruling on whether Silvio Berlusconi should be jailed and banned from public office for tax fraud.

If it goes against him, members of his centre-right party are calling for a mass resignation of its ministers, so the fragile coalition government could topple. Equally, the centre-left part of the coalition could refuse to continue working with the man who has dominated Italian politics for 20 years.

It’s just as likely that the court could postpone a decision or acquit him and it doesn’t look to be in any party’s interests to force early elections. The agony could be drawn out with the Supreme Court taking up to three days to deliver its verdict.
In the meantime, Italy will sell up to 6.75 billion euros of five and 10-year bonds, after successfully flogging 8.5 billion euros of six-month bills on Monday. Borrowing costs fell to their lowest since May at that sale.

Italy has already raised around 80 percent of its 2013 funding target and markets have recovered their poise since Federal Reserve Chairman Ben Bernanke spelled out in words of few syllables that “tapering” does not mean interest rate rises and won’t happen abruptly.

That’s all hunky dory for now but Italian banks have been the overwhelming buyers of their country’s debt so if yields start climbing the bank/sovereign doom loop could be reawakened. The Bank of Italy has extended inspections of bad loans at 20 of the country’s banks, in a review that could prompt asset sales to meet tougher provisioning criteria.

Outside the euro zone, we get Swedish GDP data for Q2, which is forecast to show anaemic growth of 0.1 percent on the quarter.

Turkey has been suffering from the broader emerging market turmoil sparked by the Fed’s QE exit strategy and by serious domestic ructions, with mass demonstrations against the government of Prime Minister Tayyip Erdogan who has blamed a “high interest rate lobby” for trying to undermine his country.

The central bank has been forced to burn a hole in its reserves to defend the lira and last week raised its overnight lending rate to 7.25 percent from 6.5. The currency has dropped as much as 9 percent against the dollar over the past few months due to capital outflows.

Today, the central bank releases its quarterly inflation report which is expected to revise up its forecast for price pressures which could in turn demand tighter monetary policy.


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