Broad-based Spanish recovery continues solidly in Q4, but some momentum loss likely in 2016

According to a final release by Spain's national statistics office (Instituto Nacional de Estadistica), the economy posted its 10th straight gain by the final quarter of 2015, following nine consecutive quarters of decline. Real GDP grew by 0.8% quarter on quarter (q/q) in the fourth quarter, after gains of 0.8% q/q in the third quarter, and 1.0% q/q in mid-2015. Meanwhile, real output was up 3.5% year on year (y/y) at end-2015, and by 3.2% in the year as a whole, a welcome acceleration from the 1.4% expansion in 2014. Previously, it had shrunk by 1.2% in 2013 and 2.1% in 2012.

The expenditure breakdown confirms that consumer spending and industrial investment remain the main engines of growth, while Spain's more competitive export sector is now receiving additional support from the recent retreat in the euro and firmer domestic spending across the Eurozone. Specifically, consumer spending and fixed investment added 0.4 and 0.3 percentage points to the overall q/q % change in real GDP, respectively. Meanwhile, net exports (with exports up 0.9% q/q and imports up 0.3% q/q) represented a 0.2 point boost to the quarterly GDP development.

Consumer spending remains a major engine of growth

Private consumption (including non-profit institutions) expanded for a 10th successive quarter when it rose by 0.7% q/q in the final quarter of 2015, compared to a 1.1% q/q gain in the third quarter. In annual terms, private spending was up 3.5% y/y in the final quarter, the strongest performance since end-2006, and rose by 3.1% in the year as a whole. Household economics continue to benefit from strong job creation, while their purchasing power is being elevated by still falling energy costs, tax cuts brought forward by six months to July 2015, and the government paying public-sector employees one-quarter of the extra salary payment suspended in December 2012. Other factors have placed household spending on a sustainable upward trajectory; consumer confidence has benefited from reduced sovereign financial tensions, alongside Spain developing a broad-based recovery, falling or marginal consumer price developments, and a lower unemployment rate compared with one year ago, triggering more upbeat spending intentions. Therefore, consumers are returning to the high street to satisfy pent-up demand for durables, attracted by discounted prices, with better conditions have encouraged households to rein back their saving rates.

Industrial investment posts further sharp gain in Q4

Gross fixed capital formation continued its upward trajectory for a ninth straight quarter when rising by 1.1% q/q during October–December 2015. Therefore, on a y/y percentage basis, fixed investment was up 6.4% both at end-2015 and the year as a whole, and has recovered steadily since early 2014 after falling continuously since early 2008. A breakdown by sector reveals that construction investment grew for a seventh successive quarter when it grew by 0.6% q/q, and was due to further strengthening in non-residential structures, and the continued recovery in home building. In annual terms, construction investment is heading north and increased by 4.6% y/y in the fourth quarter (and 5.3% in 2015 as a whole). Despite some further improvement during 2015, the construction sector faces some significant headwinds, with the housing sector still weighed down by a large stock of unsold properties and recovering but still historically low demand for housing. Meanwhile, spending on capital equipment remained on steep upward trajectory, increasing for an 13th successive quarter when it climbed by 1.9% q/q at end-2015, and was up 10.9% y/y, the 11th successive y/y percentage rise after falling continuously since end-2011. The main spur behind the upturn in corporate (excluding construction) investment has been improving financials, triggering a release of some pent-up demand for items such as new machinery (and rising capacity utilisation during 2015).

Outlook and implications

Balanced real GDP gains during 2015 alongside still sound survey data bode well for 2016 and 2017, with the recovery propped up by continued improvement in employment, household income, and corporate financials. In addition, a more positive domestic demand backdrop implies Spain is benefiting fully from converging supportive external factors, namely lower energy costs and the recent slide in the euro. We continue to argue that extended low oil prices are helping to restore consumers' purchasing power, even as limited wage growth remains a major headwind for the household sector, while elevating companies' margins and supporting higher investment and employment. The retreat in both global crude-oil prices and the euro played a major supporting role in Spain during 2015, and built on the original recovery platform of improving sentiment across the economy in line with notably calmer sovereign financial conditions, record-low interest rates, and the labour market starting to improve.

Nevertheless, we expect the recovery's pace to lose some momentum during 2016 and 2017, with real GDP growth likely to edge back to around 0.6% q/q, in line with diminishing pent-up demand among households and firms allowing more normal spending patterns, along with a more challenging external environment. In addition, the upside for near-term growth is being pushing back by political bickering following the inconclusive general election, the entrenched risk of Catalonia's secession, and growing tensions in the global economy and financial markets. Increased political uncertainty could threaten the early pillars of the recovery, namely by pushing up Spanish sovereign borrowing costs during 2016, while derailing the recent improvement in sentiment.

The political uncertainty could spark more caution in households, pushing up their saving rates in the face of concerns about the safety of the recovery and less certain labour market developments. Furthermore, the inconclusive general election, and the lack of a clear political direction on key issues such as labour market reform and fiscal consolidation is a very real threat to business confidence, implying that firms could rein back their investment and employment intentions in the face of significant uncertainty. Clearly, the risk would climb appreciably should Spain turn to a Spanish Socialist Workers' Party (Partido Socialista Obrero Español: PSOE) and "We can" (Podemos) coalition government.

Still, the near-term outlook remains encouraging when compared with most of the Eurozone, and we expect the economy to grow 2.7% in 2016 and 2.4% in 2017 from a 3.2% gain in 2015, according to our February forecast.

The main catalysts of growth likely to remain the same

As a major crude-oil importer, Spanish households are enjoying the fruits of lower global oil prices. The fall in energy costs has been a major factor behind negative or marginal consumer price inflation since mid-2014, helping stoke a firmer revival in real household incomes. Specifically, gross household disposable income in real terms rose 1.5% y/y in the third quarter of 2015, after a 2.7% y/y gain in the first half of the year. Nevertheless, despite welcome gains since mid-2014, household gross disposable income in real terms in the third quarter of 2015 was still 9.3% below its third-quarter peak in 2009. Other supports are materialising, including several income tax cuts during 2015, helping ease the pain of continual nominal wage compression.

A strong export performance will remain key to the continued recovery during 2016 and 2017. The export performance since 2013 has been the largest positive surprise, especially when noting uneven demand in key export markets across the Eurozone. Spanish export expansion has outperformed growth in world trade, with goods and non-tourism services leading the way, helped by the country's exporters increasing their presence in faster-growing economies. Spain has gained an increased export market share, which could be a reflection of recent labour markets helping generate improved competitiveness and productivity. Unit labour costs, both in nominal and real terms, have declined steadily since 2009. Therefore, increasingly competitive Spanish exports will be well placed to exploit firmer domestic demand generated by falling oil prices, both within and outside the Eurozone.

Overall fixed investment is expected to grow in 2016 and 2017, led by industrial investment. The latest data point to an improving industrial investment climate. Firms continue to unwind pent-up demand for capital goods, triggered by firmer demand emerging from the domestic economy which has sparked a revival in industrial activity. Furthermore, machinery and equipment investment continues to climb, spurred by improving financial results triggering increased demands for new machinery. A further fall in energy costs will help to lift corporate profitability, still limited by firms needing to price competitively to generate new business. In addition, demand for capital goods is being elevated by reviving Spanish manufacturing activity. Specifically, Spain continues to report firmer industrial output developments, alongside solid purchasing managers' index (PMI) results. According to the latest Markit/ADACI PMI, Spain's manufacturing activity grew for a 25th successive month in December, although the pace of expansion decelerated slightly. The seasonally adjusted PMI was 53.0, above the 50-point mark (signifying expanding activity), compared with a 2015 high of 55.8 in May.