Stable growth and inflation throughout the eurozone in 1Q14

The activity data available indicate that growth in the eurozone as a whole, including the periphery, remains stable or may have even strengthened slightly at the beginning of the year. In addition, growth is starting to be supported by the reactivation of domestic demand, while exports appear to be continuing to increase at a robust rate and are key for the recovery in investment. Inflation surprised to the upside in February, remaining stable at 0.8% YoY. Discounting a slight deceleration in March due to base effects, the disinflationary process is likely to run its course in 1Q14 and give way to relatively stable inflation in the coming months, although we still view the level as too low. Given this scenario, the ECB continues to expect a moderate recovery with stable inflation in the coming quarters (in line with our forecast), and this led it to maintain the tone of its monetary policy, with no additional standard measures (see our ECB Watch). The risks continue to be tilted to the downside, partly due to the continued strength of the euro derived from the monetary authority’s stance. 

Eurozone: the economy will grow around 0.4% QoQ and the disinflationary process will run out of steam 

• Confidence indicators were again better in February in all sectors The European Commission’s Economic Sentiment Index (ESI), was practically unchanged in February after the significant improvement it had been showing since mid-2013. It remains above its historical average so far this year, underpinned by better expectations in both the industrial and services sectors, which offset the deterioration in consumer confidence. Similarly, the composite PMI also improved again in February, this time driven by services, and indicates that the downturn at the end of last year was transitory, with the index remaining firmly in expansive terrain. In short, both surveys suggest that the eurozone economy may already be growing around its potential of approximately 0.4% QoQ in 1Q14. Furthermore, the subcomponents in both indicators suggest that improved activity is still benefiting from foreign orders (despite the strength of the euro), while the support from internal demand is gaining ground. 

• January activity data gave mixed signals, revealing a slightly more moderate scenario The (scanty) activity data available for January were a mixed bag and point to a slightly more moderate economic performance than the confidence indicators suggested at the beginning of the year. Retail sales surprised to the upside, with significant increases (1.6% MoM, 1% higher than 4Q13 after contracting 0.5% QoQ), in line with the improvement in consumer confidence over the last few months, supported by a more stable labour market (an unemployment rate of around 12% in the last year) and the moderation in inflation. This data suggests that household consumption should continue to show a degree of resilience in 1Q14.  There was a surprise to the downside with the mild decline in January’s industrial production (-0.2% MoM, 0.1% over 3Q14 after rising 0.4% QoQ), pointing to a degree of moderation in industrial activity. Export data for January are not yet available, but the surveys indicate that the big increase in orders, including those coming from abroad, may have slowed at the start of the year (world growth is still strong despite a slight slowdown in February - see BBVA-GAIN Flash -, so it is likely that the strong euro is causing this behaviour), which could put a brake on sector growth and possibly result in a more moderate uptick in investment than we saw at the end of 2013.  

• The MICA-BBVA model forecasts higher growth in 1Q14 (+0.4% QoQ) When we input the data available to date (there are only hard data up to January), our short-term forecast model estimates growth of around 0.4% QoQ in 1Q14 (after 0.3% QoQ in 4Q13). Even so, we feel comfortable with our 1Q14 growth estimate of 0.2% QoQ, since the relative optimism of the confidence data has yet to be reflected in activity data, which have not yet really taken off. 

• Inflation is stable in February, while we still expect the disinflation process to come to an end in April The rise in services and non-energy industrial goods inflation in February offset the fall in energy prices, so headline inflation stayed at 0.8% YoY in February while core inflation should have gone up slightly after the 1% YoY increase in January. Nevertheless, we expect inflation to fall a little in March (around 0.1pp) because of the calendar effect of the Easter holidays, although partly offset by a slightly easier energy prices. In the next few months, we expect inflation to increase by around 0.3pp to about 0.9% YoY in 2Q14, and remain relatively stable until the final quarter of this year, when it could return to levels above 1% YoY. Therefore the surprise to the upside in February offset in part the surprises to the downside of previous months, since core inflation was more resilient than expected. This could help to dispel fears about the intensity and nature of the disinflationary process and its possible negative effect on inflationary expectations. We still think it unlikely that disinflation will continue beyond March, and that a scenario of low and stable inflation rates around 0.9% YoY is more likely, given that internal demand recovery is taking hold. These are the values we have seen for inflation, excluding the impact of higher taxes on prices since 2Q13. Nevertheless, we continue to see downside risks, particularly derived from euro strength, while differences between countries will continue, with very low rates of inflation in the periphery and moderate rates in central European countries