Spain: increasing growth, decreasing inflation
Gradually increasing GDP growth in recent quarters and a further improvement of sentiment show that the Spanish recovery is on a solid footing. However, despite this recovery, inflation remains worryingly low.
Solid GDP growth, disappointing breakdown
Spanish GDP volume rose in 14Q1 by 0.4% q-o-q, after +0.2% in 13Q4 (figure 1). While GDP growth remains solid, the breakdown is slightly disappointing. Firstly, the largest contribution to growth came from government consumption (+0.9%-point), which can be seen as a rebound from the strong decline in the previous quarter. Secondly, net exports subtracted 0.6%-point from growth mainly as a result of the weak export figure (-0.4% q-o-q). Note that this is not a solely Spanish story as many eurozone countries had disappointing export figures in 14Q1. Thirdly, gross fixed capital formation declined modestly after two quarters of growth, which was mainly due to a large decline of construction investment. On a more positive note, private consumption (growth of 0.4% q-o-q) was able to continue its growth pace, although the subsidy programme to promote energy efficient cars seems to play an important role in the recovery seen in recent quarters. Despite the slightly disappointing GDP breakdown, we have raised our GDP growth outlook for this year to 1% (table 1) based on the ongoing improvement of sentiment levels (see below).
Inflation: rebalancing vs. debt sustainability
Spanish inflation dropped slightly in May to 0.2%, from 0.3% in April (figure 2). The full breakdown is not available yet, except for the fact that energy prices contributed +0.35%-point to the headline figure. Looking at recent developments in energy- and food prices, combined with ongoing weak domestic demand, we do not expect inflation to rise significantly in the remainder of this year. On the one hand, this low inflation environment provides an opportunity to regain price competitiveness, as negotiated wages came down in line with inflation (figure 3). However, note that low inflation makes it difficult to adjust wages fully in line with inflation due to nominal rigidities. On the other hand, the low inflation level (and chance of even minor deflation again) is worrying as it slows down the process of public and private deleveraging. On balance, we believe a higher inflation level in the whole eurozone is desirable, on the condition that the inflation differential between Northern en Southern countries remains the case. Spanish price competitiveness can still improve in such a scenario, especially as the bargaining position of employees is expected to remain weak going forward given the stubbornly high unemployment rate (25.1% in April) and the implemented labour market reforms.
Sentiment points to ongoing recovery
The ongoing improvement of sentiment levels points to a continuation of the GDP growth figures we have seen in recent quarters. Both the Economic Sentiment Indicator (ESI, 101.9) and the PMI (manufacturing 52.9 and services 55.7) remain at relatively high levels in May (figure 4). Sub-indices of export order books indicate that exports might pick up in the coming months, after the slightly disappointing export figures in the first quarter of the year. But before we get ahead of ourselves, it is good to mention that, according to sub-indices of ESI, the much desired improvement of employment expectations is still lagging.
In addition to the gradual rise of economic sentiment, there has been a clear return of confidence regarding Spanish government bonds (figure 5). We believe this is beneficial as the reduction in government funding costs has also brought down banks’ funding costs, which has translated into somewhat lower interest rates on loans to non-financial corporations. However, this is only a first step towards a more investment driven recovery as credit supply is currently still very restricted due to the ongoing clean-up of the banking sector and the effort to boost capital ratios. To sum up, rising sentiment has improved the economic outlook but the weakness of the banking sector will remain a drag on growth going forward.