Euro area macro monitor

Summary and outlook

• The euro area recovery is currently driven by domestic demand, as the global slowdown in Q1 resulted in weaker export growth. Looking ahead, survey indicators point to higher economic activity and the composite PMI, new orders suggests growth close to 0.5% q/q. We expect the improvement in consumer and business confidence together with the increase in real wage growth to lead to higher growth in private consumption and investments. In our view, there is still room for positive surprises from domestic demand as pent-up demand is high. This is especially the case in Spain, Ireland, Portugal and Greece (see Monitor: Periphery business cycle monitor, 19 June).

• Unemployment has begun to fall, together with the tamed debt crisis boosting consumer confidence. Ahead, the improvements seen in the labour market should lead to higher wage growth, putting upward pressure on inflation. However the large amount of slack in the labour market is set to limit the upward pressure on prices for some time.

• Economic progress should continue to support spread compression. This follows not least due to sovereign rating upgrades in the periphery. Moreover, the ECB’s accommodative monetary policy supports a further search for positive yield, while it should lead to steeper yield curves, higher break-even inflation and a weaker euro.

Details

• Inflation declined back to this cycle’s low of 0.5% in May. We expect it to remain low until Q4 when upward pressure from the labour market and global food prices should put upward pressure on prices (see Monitor: Euro area deflation monitor, 16 June).

• ECB stimulus package contains negative rates and a boost to liquidity to be injected over the next two years. This should drive yields lower, while supporting activity and inflation.

• Bank lending is still weak but the ECB is set to help banks’ funding situation. If capital constraints are the main issue, the ECB is preparing for ABS purchases.

• The drag on growth from the stronger currency is set to diminish after the ECB eased monetary policy. This will support inflation through higher imported inflation.

• The headwind from fiscal policy tightening continues to fade as politicians focus more on growth-promoting policies instead of trying to save their way out of the crisis.