French Q1 ‘Preliminary’ GDP Growth Below Expectations

Growth Slows Markedly in 2005

‘Preliminary’ first-quarter 2006 GDP data shows that the French economy expanded by 0.5% quarter-on-quarter (q/q), compared to growth of 0.3% q/q in the last quarter of 2005, 0.6% q/q in the third quarter, 0.0% q/q in the second and only 0.1 q/q in the first. Growth for every quarter of 2005 has been revised downwards, from 0.4% q/q, 0.7% q/q. 0.1% and 0.3% in the fourth, third, second and first quarters, respectively, leaving overall real GDP growth at 1.2% in 2005, compared to a previously reported 1.4%. Moreover, the press release reveals that the economy expanded by a lower-than-anticipated 2% in 2004 (down from 2.1%). Adding to the disappointing news, the first-quarter 2006 GDP growth figure was below the consensus forecast and Global Insight's projection, which had both stood at 0.6% q/q.

Positive Contribution from External Trade

The National Institute for Statistics and Economic Studies’ (INSEE) breakdown of the individual GDP components reveals that domestic demand continued to be the main growth driver of the French economy in the first quarter of 2006, as it was in both 2005 and 2004, contributing 0.7 percentage point to the GDP change. Within domestic demand, the breakdown highlights some interesting facts. First of all, private consumption strengthened further in the first quarter of 2006, up by a higher-than-expected 0.9% quarter-on-quarter (q/q), from 0.4% q/q in the last quarter of 2005. It contributed 0.5 percentage point to GDP growth (private consumption accounts for over one-half of the French economy). Growth in government consumption also accelerated, up to 0.5% q/q in the first quarter of 2006 from 0.1% q/q in the previous quarter.

Secondly, and in contrast with the strength of the previous GDP components, total fixed capital formation growth slowed to 0.2% q/q in the first quarter of 2006, down from 0.9% q/q in the previous quarter. Within this total, the contraction of business investment was particularly disappointing, down by 0.1% q/q, after having risen by 1.1% q/q in the last quarter of 2005. Goods news came from the external sector, as net trade made a positive contribution to growth, after having been a drag on overall growth in 2004 and 2005. Such a positive contribution was the result of the fact that exports grew considerably faster than imports. In fact, the latter slowed to growth of 1.1% q/q, from 2.2% q/q in the previous quarter. Nevertheless, we still believe that net trade will have made a negative contribution to GDP growth in 2005 as a whole. The export improvement reflects some recovery in France's main trade partners and the softening of the euro in the last quarter of the year. Export numbers might bring some modestly positive news in the next couple of months, while they continue to gather the fruits of the euro's past depreciation.

Nevertheless, the French external sector has deep-rooted problems, which make it extremely vulnerable to any temporary shock. Indeed, France has progressively accumulated trade deficits since 2000, increasing the divergence with both the Eurozone as a whole and Germany in particular. For example, French exports grew by 11.7% in volume terms between 2000 and 2005, compared to 35.5% in Germany over the same period (the latest available figures for both countries). This suggests that the movements in the euro alone cannot be held responsible for the deterioration in France's trade performance, and that French companies appear to have lost considerable competitiveness, as well as market share. The geographical specialisation of French exports is disadvantageous, as the country is not well established on rapid growth markets, like Asia. France's main trade partner is the Eurozone, where domestic demand has showed some improvement but has not yet taken off. Moreover, the recent strengthening of the euro suggests that French external trade might suffer soon. Furthermore, the euro is expected to appreciate further later on in 2006.

Substantial Fall inInventories

Finally, the stand-out element of the GDP breakdown was the substantial negative contribution from inventories, which took 0.7 percentage point off GDP in the first quarter of 2006. Firms may reduce inventories if demand is slowing, in order to keep a steady inventory-to-sales ratio. However, this does not seem to be the case in France, as domestic demand excluding inventories accelerated to 0.7% q/q in the first quarter of 2006, up from 0.4% q/q in the previous quarter. The fall in inventories might have then been the result of the fact that firms have been overly pessimistic about their sales forecasts and thus produced less than they can sell. In this case, the unexpected decrease in inventories might be signalling an upturn in economic activity, as a result of strengthening aggregate demand. Firms could soon increase production and output in the face of such strong demand for goods and services. However, domestic demand is unlikely to strengthen much further in the coming quarters. Moreover, it is worth bearing in mind that despite the buoyancy of private consumption, total investment slowed as business investment contracted. Consequently, we are slightly sceptical about the first-quarter GDP breakdown and believe that the figures could suffer some revisions.

Outlook and Implications

We see French real GDP growth at 1.8% in 2006, up from 1.2% in 2005. Global Insight believes that demand will remain the main growth driver in 2006, with private consumption growth reasonably strong, supported by some modest improvement in the labour market. Meanwhile, net exports will make a negative contribution to growth, as the expected lifeline of domestic demand will support imports, while the deep-rooted competitiveness problems of the French export sector, together with the strengthening euro against the U.S. dollar, will continue to undermine export growth.

Nevertheless, this is far from saying that strong growth has returned in France. The French economy faces a number of handicaps, most of which are expected to persist for some time. Looking at factors of a more immediate nature, high oil prices are expected to remain a threat to growth for some time to come. Consequently, we believe that the recent extended squeeze on companies' margins, mainly from high oil prices, will remain for some time, weighing down on firms' employment plans.

More worryingly, the French economy faces significant structural problems, which continue to constrain strong growth. For example, one of the challenges for the economy is to improve its labour market. Recent unemployment data has been somewhat more encouraging, but optimism should not be overstated. Although the latest labour market measures implemented by the government are likely to continue to push the unemployment rate down, they have not yet generated employment and they are unlikely to do so in the future. Indeed, the fall in the unemployment rate in recent months has been due to the government's subsidised jobs plan and demographic factors, rather than effective jobs creation. This message was confirmed by the latest non-farm payroll figures, which continued to show rather weak growth. While the structural problems constraining employment growth in France continue to be ignored, we are very reluctant to call the recent improvement significant and sustainable. Without sustainable growth in employment, private consumption is unlikely to accelerate significantly.