Global Insight Perspective | |
Significance | The 0.2% quarter-on-quarter contraction in third-quarter Eurozone GDP means that the region is now in recession as this followed a 0.2% drop in the second quarter. |
Implications | Eurozone economic activity was already faltering markedly even before it was hit hard by the worsening of the global financial crisis. The Eurozone downturn is likely to deepen further in the fourth quarter. |
Outlook | In its November forecast, IHS Global Insight projected Eurozone GDP to contract by 0.5% in 2009, following overall growth of just 1.0% in 2008. However, we are set to project significantly deeper contraction in 2009 in our December forecast. |
Eurostat has confirmed that Eurozone GDP contracted by 0.2% quarter-on-quarter (q/q) in the third quarter of 2008. This matched the 0.2% q/q GDP decline seen in the second quarter, thereby meaning that the Eurozone is in recession (defined as two successive quarters of contracting GDP). Although the weakness of the Eurozone economy in the second quarter was partly a correction to first-quarter growth of 0.7% q/q being inflated by some temporary factors (including a very mild winter, which substantially lifted construction investment), there is no denying that the third-quarter contraction was a genuine reflection of the downturn across the region. As a result, annual Eurozone GDP growth moderated to just 0.6% in the third quarter from 1.4% in the second and 2.1% in the first.
Widespread Weakness in Q3
Several Eurozone economies suffered contraction in the third quarter, with Germany and Italy entering recession. German GDP contracted by 0.5% q/q following a decline of 0.4% q/q in the second quarter. In contrast, the economy had expanded by 1.4% q/q in the first quarter, when it was boosted by very strong construction investment. Consequently, annual German GDP growth moderated to 0.8% in the third quarter from 1.9% in the second and 2.7% in the first. Italian GDP also contracted by 0.5% q/q in the third quarter after falling 0.4% q/q in the second quarter. Indeed, this was the third quarter of Italian contraction in the space of four quarters, with the result that GDP was down by 0.9% year-on-year (y/y) in the third quarter.
Furthermore, Spanish GDP contracted 0.2% q/q in the third quarter, having edged up by just 0.1% q/q in the second as the slumping construction sector and housing market weighed down ever more heavily on the economy. This was the first Spanish q/q contraction for 15 years and brought the annual growth rate down to just 0.9% in the third quarter. Meanwhile, the Dutch economy was flat q/q in the third quarter, as it had been in the second quarter. This caused annual Dutch growth to slow to 1.8% in the third quarter from 3.0% in the second quarter and 4.1% at the end of 2007. The Portuguese economy was also flat q/q in the third quarter after it had grown by 0.3% q/q in the second quarter. Portugal's annual growth rate was stable at 0.7% in the third quarter.
Somewhat surprisingly though, French GDP edged up 0.1% q/q in the third quarter after contracting by 0.3% q/q in the second. Nevertheless, annual French GDP growth halved to 0.6% in the third quarter from 1.2% in the second. Belgian GDP also grew by 0.1% q/q in the third quarter, although this was down from expansion of 0.3% q/q in the second quarter and the y/y growth rate moderated to 1.3% from 1.9%. Similarly, Austrian GDP growth slowed to 0.1% q/q and 1.5% y/y in the third quarter from 0.3% q/q and 2.0% y/y in the second. Elsewhere, Greek GDP growth moderated to 0.5% q/q and 3.1% y/y in the third quarter from 1.0% q/q and 3.6% y/y in the second, while Cyprus's expansion was reduced to 0.6% q/q and 3.5% y/y from 0.9% q/q and 4.0% y/y. Details of third-quarter GDP are not yet available for the other Eurozone countries.
Weakness Evident in Most Eurozone GDP Components in Q3
Consumer spending was only flat q/q and y/y across the Eurozone in the third quarter, having contracted by 0.2% q/q in the second quarter and having been unchanged q/q in the first quarter. Although relatively high employment and modestly higher wage growth in some countries provided support to consumer spending in the first three quarters of the year, this was countered by the squeeze on purchasing power coming from high energy and food prices. Other factors limiting consumer spending included higher interest rates through to October, tightening credit conditions, and significant concerns among consumers in some countries (notably Germany) about their long-term future personal finances in view of potential reforms relating to healthcare, pensions, and labour markets. Unsurprisingly therefore, consumer confidence has fallen back sharply throughout 2008.
Investment faltered markedly for a second successive quarter in the third quarter, having been a key Eurozone growth driver in the first quarter and throughout 2007.Specifically, gross fixed capital formation contracted by 0.6% q/q in the third quarter after falling 0.9% q/q in the second quarter. In contrast, investment had risen by 1.4% in the first quarter (although it was inflated by a mild winter, which lifted construction investment) and by 4.3% overall in 2007. Consequently, the y/y growth rate in gross fixed capital formation slowed to a mere 0.9% q/q in the third quarter of 2008 from 3.7% in the first quarter. Business investment has been increasingly hit by sharply lower business confidence, tighter credit conditions, and markedly weakening final demand.
The third-quarter q/q contraction in Eurozone GDP would have been significantly deeper but for a build-up of inventories adding 0.3 percentage point. A further 0.2 percentage point to q/q GDP was added by elevated government growth of 0.8% q/q and 2.3% y/y. This meant that Eurozone domestic demand actually edged up by 0.2% q/q in the second quarter after contracting by 0.3% q/q in the second quarter.
Net trade was sharply negative in the third quarter, cutting 0.5 percentage point from q/q GDP. Eurozone exports rose by a modest 0.4% q/q after dropping 0.1% q/q in the second quarter. Consequently, y/y growth in exports slowed to 2.4% in the third quarter from 3.9% in the second and 5.3% in the first. This indicated that the very strong euro (which peaked just above 1 euro:US$1.60 in July) and slowing growth in some key export markets (notably the United Kingdom and the United States) took an increasing toll. Meanwhile, imports rebounded by 1.7% q/q in the third quarter after falling 0.4% q/q in the second, although they were still up only 1.3% y/y in the third quarter.
Outlook and Implications
Latest data and survey evidence indicate clearly that the Eurozone recession is currently deepening. Consumer and business confidence has fallen substantially across the Eurozone and stood at a 15-year low combined in November, thereby undermining prospects for investment, employment, and consumer spending. Retail sales are generally soft, the manufacturing sector is struggling hugely, and survey evidence points to service-sector activity contracting in November at the deepest rate in at least 10 years. Meanwhile, exports are showing clear signs of faltering.
Heightened financial-sector turmoil (a number of European banks have had to be rescued or helped by the authorities), very tight credit conditions, and sharply lower equity prices are clearly hurting economic activity across the Eurozone and the full effects are still feeding through. Eurozone labour markets are now softening appreciably overall, which will increasingly counter the anticipated boost to recent sharply squeezed purchasing power coming from moderating inflation over the coming months. Meanwhile, significant corrections in overvalued housing markets in Spain and Ireland are hitting the rest of the economy hard, and this may well happen to a lesser extent in some other countries, possibly including France and the Netherlands. Finally, markedly weakening global growth is hitting foreign demand for Eurozone goods and services.
These factors are more than outweighing the help to Eurozone economic activity now coming from sharply lower oil and commodity prices, a significant retreat in the euro from its July peak of 1 euro:US$1.60 (it dipped below 1 euro:US$1.25 in November) and lower interest rates (the European Central Bank has cut its key interest rate from 4.25% to 3.25% since October).
Consequently, in our November forecast, we projected that Eurozone GDP would grow by just 1.0% in 2008, and then contract by 0.5% in 2009. All of the major Eurozone economies were forecast to endure recession. German GDP was projected to contract by 0.7% in 2009 after rising 1.3% in 2008, while French GDP was seen falling 0.3% in 2009 after growing by a very modest 0.8% in 2008. Italian GDP was projected to contract in both 2008 (by 0.2%) and 2009 (by 0.9%), while the Spanish economy was forecast to decline by an even sharper 1.0% in 2009 after expanding by a 15-year low of 1.2% in 2008. Modest Eurozone recovery was forecast to develop in 2010, resulting in 0.8% growth over that year. However, we are set to revise these projections downwards significantly further in our December forecasting round.