Euro area: Ireland takes over from Greece

Euro area: Ireland takes
over from Greece


Europe’s sovereign debt crisis is writing a new chapter in themonth of November. On this occasion, the protagonist is Ireland but once again the rest of the so-called periphery countries have played an important part. The recovery of the euro area is once again out of the limelight, although the latest figures have been relatively good. In the third quarter, gross domestic product (GDP) grew by 0.4%quarter-on-quarter, which will probably push growth for the whole year above our forecast of 1.5%.

Returning to themain issue, the origin of the Irish crisis lies in its banking system.While Greece’s problemis particularly its competitiveness and the lack of transparency in public sector management, there aremuch fewer doubts regarding the Irish economy’s growth potential. The Celtic tiger’s problemis the significant adjustment in its housing sector and its overlarge banking sector. In 2009, when the international financial crisis was at its peak, the Irish government promised to guarantee all bank assets to avoid financial panic in its economy.


But the hole created by the real estate sector in its banks has been larger than expected. In fact, after the summer the Irish government had to inject even larger amounts of capital into its banking system, pushing the deficit expected for this year up to 32%. This set all the warning bells ringing and the international community quickly picked out Ireland as themain candidate to succeed Greece in the sad tale of developed countries that have needed bailing out.


One of the direct consequences was the total closure of international financing markets for the Irish banking system, forcing it to obtain liquidity fromthe European Central Bank. However, what actually sent risk premia soaring were statementsmade by the German chancellor, AngelaMerkel, suggesting that any bailout through the Financial Stability Facility would have to be accompanied by a restructuring of debt, which would lead to losses for those holding the country’s debt.

The size of the bailout, 85 billion euros, is expected to be aimedmostly at strengthening the banking sector’s capital but new fiscal adjustmentmeasures will also have to be taken. This should be enough to calmdown themarkets. However, they will probably redirect their attention towards the rest of the periphery countries and particularly Portugal, which will have to prove that its fiscal austerity plans are being applied to the letter and also that this isn’t harming the economy’s ability to grow, something that looks difficult to achieve.


In spite of doubts regarding the sustainability of periphery countries’ public debt, the fact is that the GDP flash estimate for the euro area is quite robust. After strong growth in the second quarter, namely 1.0%quarter-on-quarter, the pace of growth has remained relatively strong and we have therefore had to improve our growth forecasts slightly for this year, up to 1.7%. Once again, Germany has been the driving force behind the European recovery for yet another quarter. However, we still expect growth to remain atmoderate levels in the coming quarters and itmight even fall slightly.


This is suggested by the different supply indicators. Industrial production, for example, which grew strongly in the second quarter, lost its impetus in the month of September after a drop of 0.9% compared with the previousmonth. It’s still too soon to determine whether the pace of growth we have become used to of late will slow up, but the risk has decreased slightly. It’s important to note that this change in trend, if it occurs, will be slight, as the purchasingmanagers’ index (PMI) was still showing signs of strength in November.

The evidence provided by the different demand indicators is alsomixed, so that consumption will have probably remained at a relatively weak rate of growth in the third quarter, as in the last few quarters. Retail sales are still very flat and show no sign of picking up. The other side of the coin is consumer confidence and inflation. Regarding confidence, November saw renewed improvement and this continues to rise.


The variation in prices also points to a slight change in trend in demand’s mood. This can be seen in the rising year-on-year rate of change for the core harmonized consumer price index, up 1.1%in themonth of October after fourmonths stuck at 1%. However, until the labourmarket shows clear signs of improvement, consumption won’t return to faster growth rates. Something that’s not expected to happen until the end of the
coming year.


Lastly, it’s worth noting the trends in the foreign sector. During the third quarter, both exports and imports kept to a yearon-year pace of growth of between 20% and 30%, so that the feared effect of the dollar’s depreciation has been very limited so far. In fact, the euro depreciated rapidly in November as the Irish debt crisis gained strength. However, we expect the euro tomake up the ground it lost against the dollar once themeasures to support Ireland have been determined.

In short, the euro area’s economy is certainly going through a delicate time. It’s very important for Ireland’s bailout plan to be approved quickly and very transparently to avoid uncertainty from spreading to other countries. It’s equally important for the different countries in the euro area to study the situation of Portugal and, if necessary, anticipate the markets by approving an aid package should the country really need it. The euro area’s recovery is on the right track but a small political fault in handling the bailoutmay have highly negative consequences.


Good prospects for Germany in 2011
The German economy reduced its pace of recovery between July and September, with a 0.7%rise quarter-on-quarter. An increase that nonetheless shows «solid growth» according to the annual report drawn up by the panel of economic experts that advises the German government. In this report, «the five wisemen» raised their forecasts for GDP growth to 3.7%for this year and to 2.2%in 2011. Should these forecasts be right, the German economy would reach the peak it achieved in 2008 bymid-2011.

A breakdown of the growth in the third quarter into its different components shows the German economy to bemore balanced, continuing the trend established since it exited the last recession.


In this respect, domestic and foreign demand havemade very similar contributions to growth of 0.4 and 0.3 percentage points respectively. Of note is the recovery in public consumption, up 1.1%compared with the previous quarter and contributing two tenths of a percentage point to GDP growth.

With regard to the foreign component, trade flows have dipped, reducing their pace of growth by around six percentage points compared with the previous quarter.

Although growth was still healthy in the third quarter, the intense correction of themost frequent indicators in September raises renewed doubts regarding future trends. Industrial production for September fell by 0.8%
compared with August, neutralizing a large part of the growth recorded during the previousmonth.Moreover, the strong shrinkage in industrial orders in September, down 3.5%month-onmonth, suggests that industrial activity will grow at a slower pace in the last quarter of the year. This has been confirmed by the slowdown in the growth of industrial capacity utilization in November, a slightmoderation being predicted in the rise in investment in this period.


As regards demand, retail sales fell again in September for the second consecutive month, down 1.7%month-on-month. Consequently, retail trade was practically at the same level as that reached a year ago. Only exports grew in September, up 3.0%month-on-month, boosted by trade with non-EU countries. This, and
the fall in imports in the same period, down 1.5%, boosted the balance of trade in September by 46.6%year-on-year.


Does this dipmean that domestic demand will come to a standstill in the next few quarters? The upward trend in confidence indicators in October suggests that this won’t happen and point to renewed growth in the economy, although perhaps at a slower rate. This can be seen in the graph above, where both the IFO economic sentiment index and the consumer confidence index are approaching levels very close to the records achieved in 2007. The last case is due to the solidity of the labourmarket, with the unemployment rate remaining at 7.5%in October, the lowest since 1992.

A figure that, according to the five wise men, will continue to fall in 2011, although far fromfull employment, the German chancellor’s goal for the coming years. Germany will therefore start 2011 with very good economic prospects, both in terms of its stronger domestic demand and the gradual recovery in its exports.


Given this scenario, the German government believes its priority is to consolidate its public accounts and get its deficit below 3%of GDP as soon as possible. That’s why no-one is expecting taxes to be lowered next year. An austerity policy it wants to share with the rest of the euro area’smembers, especially within the current context of high tension in the sovereign debt markets.
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