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Spain’s economic growth slows, but outlook remains solid

Economic Update

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  • In the second quarter of 2018, Spain’s economy grew by 0.6 percent compared to the first quarter
  • This implies growth slightly slowed down from 0.7 percent in the first quarter, but does little to undermine Spain’s economic recovery
  • We forecast the economy to grow by 2.7 percent in 2018 and 2.2 percent in 2019
  • Spain’s short-term economic outlook compares favourably to the 2 percent growth we expect for the entire Eurozone this year
  • This does not mean the government has the luxury to be complacent, however, given the still weak government finances
  • Still, we deem it unlikely that the new minority government will deal with Spain’s longer term economic and fiscal challenges
  • We should give the new Prime Minister credit though, for the easing of tensions with Catalonia

In the second quarter of the year, the Spanish economy grew by 0.6 percent compared to the previous quarter. This implies a slight slowdown after quarterly growth of 0.7 percent in the first quarter, but it is still twice the rate by which the entire Eurozone economy grew (figure 1). The industrial sector performed better than in the first quarter of the year, while growth in the services and construction sector slowed down. Regarding expenditure components, investment growth significantly strengthened, but private consumption growth substantially slowed and export growth even contracted. It seems that export to other euro area countries has held up well, though. All in all, the contribution of domestic demand was positive, even more so than in the previous quarter, while the contribution of foreign demand and inventory building was negative (figure 2).

The strong contribution of domestic demand underlines the strength of Spain’s economic recovery and bodes well for the future. That said, while investment growth still has to prove its resilience, the slowdown in consumption growth is unlikely to be temporary. The outlook for export growth remains uncertain as decent growth expectations for important trading partners coexist alongside possibly some lagged effects of the appreciation of the euro last year, slowing tourism activity growth, and trade tensions.

Looking forward, we stand by our growth forecast of 2.7 percent for 2018 and 2.2 percent for 2019.

Figure 1: Spain does it again
Figure 1: Spain does it againSource: Macrobond
Figure 2: Investment drives growth in 18Q2
Figure 2: Investment drives growth in 18Q2Source: Macrobond, Rabobank calculations

Can investment spending keep it up?

Investment growth recovered strongly in the second quarter after a weak start to the year. In our view, the outlook is pretty strong, but some caution is warranted. On the upside, good order books and rather high capacity utilisation rates, especially in the services sector, alongside good financing conditions support investment growth. The recovery in the housing market and the overall construction sector also plays an important role (figure 3). On the back of an improving labour market, affordable financing and a large potential for pent-up demand, the recovery still has a large course to run. Moreover, whereas the recovery is still concentrated in the big cities and coastal areas, it has slowly started to spread throughout the rest of the country. Finally, public investment will benefit from the expansionary measures in the 2018 budget, which has been adopted only recently.

Figure 3:  The housing market is on the mend
Figure 3:  The housing market is on the mendSource: Macrobond, Rabobank calculations
Figure 4:  Manufacturers are becoming less upbeat
Figure 4:  Manufacturers are becoming less upbeatSource: Economic Sentiment Indicator EC, Rabobank

On the downside, producer sentiment and capacity utilisation rates in the manufacturing sector are weakening (figure 4), and also the uncertain export outlook and tighter profit margins due to higher energy costs could temper investment growth. Furthermore, in the ‘Survey on the access to finance of enterprises’ of the European Commission, a quarter of the Spanish SMEs states that finding customers is the most important problem they are facing, compared with a third of the SMEs during the crisis heights. If they lack customers for their products, it might be less urgent for them to invest. Only 8 percent of the SMEs says that access to finance is their biggest challenge.

Consumption growth has passed its peak

As expected, improving labour market conditions in the second quarter were insufficient to fully offset the negative impact of higher oil prices (figure 5), lessening pent-up demand and the ultra-low saving rate (figure 6). The latter limits the room and willingness to increase spending at a faster rate than income growth. In fact, when we correct for payments on outstanding debt, average figures suggest that Spanish households have a negative (active) saving rate, i.e. they spend more money than they actually earn. While we have to be careful drawing conclusions from such numbers, it indicates that past consumption rates are not sustainable in the long run. We think that all the above factors will keep consumption growth in a bind for the remainder of the year. That said, steadily increasing nominal wage growth allows some recovery in consumption growth going forward. Lower taxes and higher minimum pensions and public wages as adopted in the 2018 budget will also help. 

Figure 5: Real wage growth turns negative again
Figure 5: Real wage growth turns negative againSource: Macrobond, Rabobank calculations
Figure 6: Household saving rate at historically lows
Figure 6: Household saving rate at historically lowsSource: Macrobond, Rabobank calculations

Weak mandate limits policy options Sanchez, for better or worse

Spain’s short-term economic outlook compares favourably to that of other large Eurozone countries. Looking a bit further down the line, it is warranted, though, for the government to enhance the country’s long-term growth outlook and to strengthen the structural government budget balance. This is necessary to prevent debt sustainability issues in the longer term and to lower the country’s vulnerability to future economic shocks.

Given the current Sanchez government’s weak mandate, dependence on the far-left Podemos and its eagerness to win back voters – not forgetting the possibility of early elections – we should not expect bold measures to improve public finances. Nor do we believe the government will devote much time to possible measures with (only) long-term gains for the economy. On the contrary, while major policy changes are unlikely, some fiscal slippage is. Our line of thinking was confirmed by the economic plan recently put forward by Sanchez. The plan includes higher public spending, only partly compensated with higher taxes, leading to higher budget deficits.

But the plan was rejected by parliament. This confirms that it will be extremely difficult for Sanchez to navigate policy measures, let alone the 2019 budget, through parliament later this year. A failure in doing the latter would likely result in early elections next year. Uncertainty might weigh on the short-term economic outlook, but early elections are not necessarily bad for Spain’s longer term economic outlook.

It is worth noting that, partly because of Sanchez, Catalan tensions have eased. Sanchez has promised dialogue, and his first move has been to suggest freeing public money to invest in Catalonia. An independence referendum remains the ultimate goal of the Catalan government, however, something which Sanchez and his PSOE are opposed to. So while tensions are unlikely to reach the highs we saw in the final months of 2017, they are here to stay for a long time.

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