The French economy continues to feed on domestic consumption

The French economy continues to feed on domestic consumption

The recovery in the French economy continued apace in the third quarter of 2010, with GDP up 0.4% quarter-onquarter and the year-on-year change up to 1.8%. Thismeans that France has enjoyed quarter-on-quarter growth for the last six quarters, practically ruling out the possibility of a double-dip recession.

Breaking down French GDP’s trends into its main components we can see that domestic demand continued to drive the economy, up 0.6%during the third quarter. The figures also confirmthat investment is playing its part in the recovery as this was up 0.5% in the third quarter compared with the previous quarter, after the 0.9% rise posted in the second quarter. There have therefore been two quarters of positive figures, contrasting with the decline in investment recorded in the previous two years. For its part, private consumption continued to be the engine of growth for the French economy with a 0.6%rise quarter-on-quarter, while public expenditure grew by 0.4%.

Looking at foreign demand, imports remained dynamic, up 4.1%, greater than the 2.5%rise in exports and therefore deteriorating the trade balance. However, the negative contribution of foreign demand to GDP was partially offset by corporate restocking, adding 0.3%to growth.

Leading indicators point towards the growth in economic activity remaining strong but with relativelymoderate rates, in line with the French recovery. From the point of view of supply, an analysis of the figures shows that industrial production was up 5.1%year-on-year in the third quarter of 2010, although this was stillmore than 10%below the pre crisis peak. This suggests that the French production fabric will continue to improve with positivemonth-on-month rates, albeit probably with some ups and downs.

In fact, the outlook is favourable according to the business confidence indicator in the Bank of France’s report on the French economy from 9 November. Based on this variable, the Bank predicts 0.5%growth in the fourth quarter compared with the previous quarter. This figure is in line with the OECD’s growth prospects for the French economy in 2011, predicting year-on-year growth of 1.6%, very similar to the growth expected for this year.

The data point also toward demand continuing to grow,mainly thanks to household consumption, which is expected to remain strong over the coming months, while public expenditure is expected to fall with the
implementation of austeritymeasures. With regard to investment, this tends to grow when the index of production capacity utilization exceeds its long-term average (around 80 points). According to the Bank of France’s report on the economy, this variable fell by four tenths of a percentage point in October to 76.4

points, so it is expected to contribute a little less to growth in the last quarter.

In short, French activity is likely to continue recovering slowly but surely in 2011, thanks to private consumption performing well andmore dynamic investment. All this within a context of a change in government, after the extensive cabinet reshuffle carried out by president Sarkozy on 14 November.

The Italian economy is showing some gaps after its recovery

The pace of growth for Italian GDP fell in the third quarter of 2010, up 0.2% quarter-on-quarter, the lowest level for the year. This slowdown highlights the Italian economy’s structural weakness as, after a short period of recovery, it is once again facing the same problems as before the crisis started. Consequently, after an
expected upswing in 2010 of around 1%, growth is not expected to be any faster in the coming year.

In spite of not having the breakdown of GDP by component, the stagnation in private consumption and the lower investment, due to the end of tax incentives in July, slowed up their growth in the third quarter. In the

case of consumption, the rise in the unemployment rate and slow progress for wages damaged household confidence. This resulted in almost zero growth in retail sales for July and August 2010 and the consumer
pessimism recorded in October suggests that this trend will continue in the fourth quarter.

Moreover, the foreign sector’s contribution, which played a leading role in the second quarter’s recovery, is also showing signs of running out of steam. The trade deficit therefore tripled in September compared with the same month last year, due to imports rising more strongly. The decline in industrial production in September consequently comes as no surprise, namely 2.1% month-on-month.

The economic outlook for the coming year isn’t much more encouraging for Italy. The expected lower contribution of foreign demand in 2011 and weak consumption, both public and private, will keep Italian growth below the average for Europe. A scenario that would require the implementation of structural measures to boost Italian competitiveness. Something that is not feasible in the short term due to the

country’s political instability, which might lead to early elections.

The British economy is picking up faster than expected
The British government is currently implementing a drastic austerity plan that aims to reduce the deficit from 10% of GDP this year to 1.1%by 2015-2016.  One of the risks of these cuts is that they might put a stop to any economic recovery.However, themore consolidated this reactivation process, the greater the probability of withstanding the cuts carried out next year. In this way, the fact that the GDP flash estimate for the UK in the third quarter was 0.8%, double the figure expected by the consensus, came as a pleasant surprise. This raised the year-on-year change to 2.8%, the highest increase since 2007. Another encouraging aspect is the fact that GDP growth for this quarter was largely due to the private sector.

The good performance of the British economy in the third quarter coincides with the favourable trend in the labour market. During July-September, 167,000 jobs were created, helping to reduce the unemployment rate by one tenth of a percentage point to 7.7%. Nonetheless, the fiscal consolidation efforts beingmade might still slow up the recovery. This will largely depend on business confidence and the boost that could be provided for exports by a depreciated pound sterling.

In effect, an analysis of themost frequent figures suggests that British industry will continue to recover, albeitmore gently. Supply indicators point to entrepreneurs’ confidence in October being below the level recorded in previousmonths.Within this context, the National Institute of Economic and Social Research estimates that the British economy grew by 0.5% in the threemonths up to October, denoting
a certain slowdown in the pace of growth.

On the other hand, the outlook for demand partly depends on whether households and companies wish to save. As regards household consumption, the bulk of the evidence available suggests that this will risemoderately. Although the consumer confidence index improved in October, its behaviour is somewhat

erratic.Moreover, some households are still verymuch in debt. Regarding investment, surveys point towards some improvement. According to the Bank of England’s Inflation Report for November, a larger number of
entrepreneurs plan to increase their savings over the next twelvemonths.

Looking at the trends in inflation, this increased by one tenth of a percentage point in October to 3.2%, once again higher than the expected level. Inflation is therefore still at a level that is significantly higher than the Bank of England’s target for price stability, namely 2%. Although inflation is not expected to fall below 2% before 2013, for themoment the Bank of England is resisting any rise in interest rates as this would harmthe recovery in economic activity

In short, the United Kingdom’s economy is expected to continue to recover,
although less strongly, partly due to the significant readjustment planned by the
government.However, the fact that British GDP has seen solid growth in the last two
quarters practically rules out the possibility of a double-dip recession.

Emerging Europe, 2011: momentum, cycle and financial risk
What can we expect fromemerging Europe in economic terms? Perhaps the best way to present our forecasts is to compare this year, 2010, with what we expect for the coming year. First of all, 2010 will have been the year in which the incipient recovery started in the second half of 2009 became consolidated.

Nonetheless, this is a strongly uneven recovery. In spite of all the economies we usuallymention in this section enjoying improved activity in 2010, namely Poland, Slovakia, the Czech Republic, Hungary and Romania, there will be notable differences between them.

Romania will not have avoided another drop in GDP due to the need for tough adjustments in its public accounts. A similar process, albeit less intense, to that carried out in Hungary, leading to positive but low growth in 2010. The other three economies will have ended 2010 with average annual growth of around 2%-4%.

Expansion in the region will have been mainly due to the pull fromexports and, to a lesser extent, restocking. In other words, because of improvements in the euro area. Themain exception will be Poland, whose domestic demand has been stronger. Lastly, 2010 will also be remembered as only partly reflecting the strong pressure on country risk that other economies on the periphery of the European Union have suffered from appreciably.

What path will the region’s economy take in 2011? The four previous trends, and their expected evolution, could be given four different labels. The first, momentumcontinues. In other words, the resurgence looks like continuing. Growth figures for the third quarter have been a pleasant surprise. Except for Romania, a country immersed in heavily reducing its public expenditure, GDP grew in the remaining countries in quarter-on-quarter terms during this period.

Confidence indicators, after weakening a little at the end of this third quarter, have also picked up again at the beginning of the last quarter of 2010. This trend, which points to a positive start for 2011, is backed by the growth scenario we forecast for the euro area, which should grow around 1.6%in the coming year.

Second label: less cyclical disparity. The region’s economies will seemore similar trends in 2011. First of all, the five countriesmentioned will record positive GDP growth, Romania around 1.0%and the other four between 2% and 3.5%. Or, in other words, while the difference between the country that grew themost (Slovakia) in 2010 and the one that grew the least (Romania) will have been close to six percentage points, in 2011 this gap (the two extremes being, once again, Romania and, this time, Poland) will be around two
percentage points.

A third summary could be «recomposing growth». Under this somewhat enigmatic label we’re simply pointing out that, in 2010, exports and stocks were themain engines behind growth, while in 2011 this is expected to be exports and investment. Domestic demand will therefore gradually start to play amore important role, a situation that will improve the sustainability of the recovery,making it less dependent on the state of the euro area’s economy.

The last of these labels for the future could be «limited political and financial volatility». To date, international investors have been precise when differentiating between sources of country risk. The current risk premia
(estimated by the so-called Credit Default Swaps, better known by their abbreviation CDS) point towards three categories of countries. Romania and Hungary are in a high country risk zone (in the order of 300 basis points but lower than Portugal’s rate, for example).

Poland, whose fiscal situation is less pressing than that of the countries we have justmentioned but far from being completely satisfactory, remains in the zone of 125 points. Lastly, the Czech Republic and Slovakia are
at low levels, in the zone of 70-80 points.

The recent tension in debtmarkets resulting fromIreland’s problems has hardly been felt by the CDS of Hungary and Poland and has had zero impact on the rest of the countries. This picture has been repeated
throughout the differentmoments of crisis in investor confidence in Europe, and we believe it’s likely to follow the same pattern in the coming months.

Themain sources of financial volatility should therefore be notably idiosyncratic, i.e. resulting fromdomestic economic policy and limited to the national sphere. Thismeans that the odd point of tension cannot be ruled out for Hungary and Romania throughout the year, two countries whose efforts to cut their public deficit might lead to domestic problems.

None of this, however, is sufficient reason to believe it will affect the recent trend of international financial flows picking up andmoving towards the region’s countries.
Full report: The French economy continues to feed on domestic consumption