Eurozone's Economic Woes Highlighted by Renewed GDP Drop in Q2

A preliminary estimate from Eurostat indicates that the Eurozone suffered a renewed GDP contraction of 0.2% quarter-on-quarter (q/q) in the second quarter of 2012. This was slightly less than the anticipated IHS Global Insight August forecasts of a 0.3% q/q contraction. The data confirms that the single currency area is in recession in all respects barring the technical definition of two successive quarters of negative GDP. Reinforcing this point, Eurozone GDP was down by 0.4% year-on-year (y/y) in the second quarter of 2012. Furthermore, while the main weakness in the second quarter continued to occur in the struggling southern periphery Eurozone countries, it was notable and worrying that economic activity generally weakened in the core northern Eurozone economies as well, indicating that they are being dragged down by the problems of Greece, Spain, Italy, Portugal and Cyprus. Germany remained relatively resilient but even its growth rate slowed to 0.3% q/q from 0.5% q/q in the first quarter.

Eurozone GDP had previously been flat q/q in the first quarter of 2012 following a decline of 0.3% q/q in the fourth quarter of 2011. It was only a clear positive net trade performance and relatively decent growth in Germany that prevented the Eurozone from contracting in the first quarter.

The Eurozone has been struggling markedly since the first quarter of 2011 as GDP only edged up 0.1% q/q in both the third and second quarters of 2011 following an expansion of 0.8% q/q in the first quarter (when it had been inflated by some catch-up effect from activity lost to severe weather in several countries in the fourth quarter of 2010). Overall, Eurozone GDP growth amounted to 1.5% in 2011, which was down from 1.8% in 2010. The Eurozone had earlier returned to growth in the third quarter of 2009 following five successive quarters of overall deep contraction during the 2008/9 recession.

Weakness Widespread in Q2

Unsurprisingly, the struggling southern periphery Eurozone economies all saw further contraction in the second quarter of 2012 as various combinations of tighter fiscal policy, high and rising unemployment, wage cuts, high debt levels and still-elevated market interest rates resulting from the sovereign debt crisis took a toll.

Italian GDP plunged 0.7% q/q in the second quarter of 2012, which was only marginally less than the 0.8% q/q drop suffered in the first quarter. Furthermore, it was the fourth successive fall in Italian GDP as it had also contracted by 0.7% q/q in the fourth quarter of 2011 and by 0.2% q/q in the third quarter. Consequently, Italian GDP was down 2.5% y/y in the second quarter of 2012.

Meanwhile, Spain suffered a third successive, and deeper, quarter of contraction as GDP declined by 0.4% q/q in the second quarter of 2012 following drops of 0.3% q/q in both the first quarter of 2012 and the fourth quarter of 2011. Spanish GDP had earlier stagnated in the third quarter of 2011 following six successive quarters of modest growth. Spanish GDP was down 1.0% y/y in the second quarter of 2012.

Portugal suffered a seventh successive quarter of contraction in the second quarter of 2012, the rate of decline worryingly, picked up sharply to a 1.2% q/q drop from 0.1% q/q in the first quarter. Portuguese GDP was down 3.3% y/y. Additionally, the decline in Cyprus' GDP accelerated to 0.8% q/q in the second quarter from 0.4% q/q in the first. This pushed GDP contraction up to 2.4%. Meanwhile, the year on year decline in Greek GDP narrowed to a still substantial 6.2% y/y in the second quarter of 2012 from 6.5% y/y in the first quarter and 7.5% in the fourth quarter of 2011 Although Greece is currently not releasing its quarter on quarter GDP data, it is now well into its fifth year of recession.

However, GDP declines were not limited to the southern peripheral Eurozone economies in the second quarter of 2012. In particular, Belgian GDP slumped by 0.6% q/q and 0.4% y/y. Belgian GDP had previously edged up by 0.2% q/q in the first quarter after a marginal drop of 0.1% q/q in the fourth quarter of 2011. In addition, Finnish GDP relapsed by 1.0% q/q in the second quarter, which more than wiped out the 0.8% q/q gain in the first quarter and limited y/y growth to 0.6%.

Furthermore, French GDP was only flat q/q in the second quarter, as it had been in both the first quarter of 2012 and the fourth quarter of 2011.This resulted in y/y growth of just 0.3%. French GDP had previously risen by 0.3% q/q in the third quarter of 2011. Although it has technically avoided recession, France has struggled for growth since expanding 0.9% q/q in the first quarter of 2011.

Importantly, though, the dominant German economy managed to keep growing in the second quarter, albeit at a reduced rate. Specifically, its rate of expansion dipped to 0.3% q/q from 0.5% q/q in the first quarter; this caused y/y German growth to moderate to 1.0% in the second quarter of 2012 from 1.2% in the first quarter and a peak of 4.7% in the first quarter of 2011. German GDP had previously edged down 0.1% q/q in the fourth quarter of 2011 following expansion of 0.4% q/q in the third quarter, 0.5% q/q in the second quarter and 1.2% q/q in the first quarter.

The Dutch economy grew 0.2% q/q in the second quarter as it had done in the first. The Dutch economy has returned to modest growth after GDP contracted 0.6% q/q in the fourth quarter of 2011 and 0.4% q/q in the third quarter. The Netherlands has been affected significantly by a slump in its housing market and GDP was still down 0.5% y/y in the second quarter of 2012. Austria also expanded 0.2% q/q in the second quarter of 2012, which was down from growth of 0.5% q/q in the first quarter and left GDP up 1.0% y/y.

Elsewhere, Slovakian growth held up well in the second quarter as GDP expanded 0.7% q/q as it had done in the first quarter; GDP was up 2.9% y/y. There was also growth in Estonia (0.4% q/q and 2.5% y/y). Second-quarter GDP data for Ireland and Slovenia have yet to be released.

Poor Consumer Spending and Investment Likely Behind Q2 Contraction

A component breakdown of Eurozone GDP growth in the second quarter of 2012 is yet to be released. Available data from individual countries is mixed but the overall emerging impression is that consumer spending and investment are generally weak, while net trade is likely to make only a modest positive contribution as exports lose momentum in the face of muted global growth.

Consumer spending likely contracted overall in the Eurozone in the second quarter. While the Federal Statistics Office indicated that it rose in Germany, it fell 0.2% q/q in France and remained weak in the Netherlands. There can be little doubt that consumer spending was hit hard in southern periphery countries giving elevated and rising unemployment and the squeezing consumer purchasing power. Eurozone retail sales volumes declined to 0.7% q/q, only adding to suspicions of a contraction in the second quarter.

Investment also appears to have been weak overall across the Eurozone in the second quarter despite seeing growth of 0.6% q/q in France (with business investment up 0.7% q/q). Investment was reported to have contracted quarter-on-quarter in Germany, especially spending on machinery and equipment.

Meanwhile, net trade seems likely to have made a positive contribution to Eurozone GDP in the second quarter, but less so than in the first quarter. In Germany, the q/q increase in exports was reported to be only “slightly” higher than in imports, while French net trade was markedly negative (by 0.5 percentage point). However, net trade was reported to have been positive in a number of countries including the Netherlands.

In the first quarter of 2102, it was only a strong net trade performance that prevented the Eurozone contracting. Specifically, net trade contributed 0.5 percentage points (pp) to q/q Eurozone GDP in the first quarter as exports of goods and services rose by 1.0% q/q and imports edged up just 0.1% q/q reflecting the weakness of Eurozone domestic demand. Exports were up 2.9% y/y in the first quarter, while imports fell 0.3% y/y.

Highlighting the underlying weakness of the Eurozone economy, domestic demand contracted 0.5% q/q in the first quarter, largely due to a 1.4% q/q drop in total investment. This left investment down 2.2% y/y. Business investment was generally weak across the Eurozone in the first quarter as it was pressurized by low business confidence, major uncertainty over the outlook, below-average capacity utilization in most countries and muted demand. In addition, tight credit conditions likely hampered investment in some countries, particularly by smaller companies. A running down of inventories was also a significant factor weighing down on Eurozone GDP in the first quarter. Indeed, it knocked 0.2 pp off q/q GDP.

Furthermore, consumer spending was only flat q/q across the Eurozone in the first quarter of 2012, causing it to be down 0.6% y/y. Meanwhile, government spending edged up 0.2% q/q across the Eurozone in the first quarter but was down 0.3% y/y, reflecting the fiscal consolidation efforts going on in several countries.

Outlook and Implications

Not only did the Eurozone return to contraction in the second quarter, but latest data and, particularly, survey evidence suggests that the single currency area is continuing to struggle markedly in the third quarter.

There are some hopeful developments for the Eurozone with oil prices falling back markedly overall from their March peak levels (although they have worryingly moved back up appreciably from 18-month lows in early-June). On the assumption that oil prices do not sustain their recent rally, this should help consumer price inflation to come down further and ease the squeeze on consumers' purchasing power. Lower input prices will also ease the pressure on companies’ margins. Meanwhile, Eurozone competitiveness will be helped by the euro sinking to a two-year low against the dollar in July.

However, tight fiscal policy in many countries, tight credit conditions, high and rising unemployment and muted global growth will continue to weigh down on Eurozone growth. Furthermore, the Eurozone sovereign debt crisis is still highly problematical despite the relatively favourable Greek election result in mid-June, some encouraging steps taken at the EU leaders’ summit in late June to ease pressure on Spanish and Italian funding costs and move towards greater banking integration, and the European Central Bank (ECB) indicating in August that it is prepared to act to limit risk premia in the bond markets. Consequently, uncertainty remains high, which is likely to cause businesses to limit their investment and consumers to hold back on their spending.

Our August baseline forecast is for Eurozone economic activity to suffer further contraction in the third quarter (by around 0.3% q/q) and then stabilize in the final quarter. This is seen resulting in Eurozone GDP contracting 0.5% in 2012 (revised down from a drop of 0.4% in our July forecast). GDP is expected to contract sharply in Greece (by 6.3%) and Portugal (by 2.8%) in 2012, while GDP declines are also forecast in several other countries including Italy (2.1%), Spain (1.3%) and the Netherlands (0.8%). Meanwhile, Germany is seen achieving modest growth of 0.9% while French GDP is seen only flat.

Our baseline forecast now is that Greece will stagger on in the Eurozone until 2013, but must ultimately exit. We assume that Eurozone policymakers move significantly towards much greater financial and fiscal union over the coming months and that this process gains increasing momentum as a Greek exit looks ever more probable. This is seen limiting the collateral damage from the Greek exit, along with major support from the European Central Bank.

Nevertheless, heightening uncertainties and tensions as the Greek exit approaches is seen increasingly weighing down on Eurozone economic activity during the first half of 2013, and the actual exit is likely to trigger overall contraction in the second half of the year, particularly in the third quarter.

Consequently, Eurozone GDP is seen contracting 0.2% in 2013 (revised from a drop of 0.1% in our July forecast). Including Greece, Eurozone GDP contraction is seen at 0.3% in 2013. Spain (1.8%), Italy (1.3%) and Portugal (1.9%) are expected to suffer further appreciable GDP contraction. French GDP is seen edging down 0.1% in 2013, but Germany is seen managing to grow by 0.7%.