Will It Last ?

Activity finally switched back to growth in the second quarter of 2013, posting, the first increase since late 2011. Domestic demand was a key factor behind this rebound, which may suggest that the recovery has legs. However, some caution is warranted. Several factors may stop the recovery process going forwards. Domestic demand, although improving, is still fragile while the external sector may suffer from a slowdown in global activity. Under these conditions, the ECB is expected to maintain its accommodative monetary policy stance. Any change in interest rates will be down.

Positive short-term news….
GDP growth surprised on the upside in the second quarter of the year, rising by 0.3% q/q. This was the first increase since late 2011. Temporary factors, mainly related to adverse weather conditions, might have artificially boosted activity particularly in the energy and construction (although less) sectors. However, as signalled by the recent improvement in confidence indicators, this was not the only reason behind the Q2 performance. Domestic demand finally brought a positive contribution to growth after constantly dragging on activity over almost two years (see chart 1).

Consumption recorded the first increase in a year and half. Over the past couple of years real income suffered from the non-favourable employment dynamics, from moderating wage growth and, mainly in 2012, from higher inflation rates. More recently, however, real income had benefited from a significant moderation in inflation, which compensated the slowdown of wages, and by a moderation in fiscal tightening. Those factors have boosted households’ confidence over recent months. Not surprisingly, it increased mainly in those countries recording the largest reduction in fiscal tightening. Italy is a case in point. After exiting from the excessive deficit procedure, the Italian Government decided to remove the tax on the first residential property (which had been just re-introduced by the Monti Cabinet in late 2012) and to postpone, for the time being, a VAT increase (1 point to 22%) originally due in July 2013. The government has also started paying its arrears to the private sector, in line with the plan decided early this year (around EUR 40bn or 2.5% of GDP).

Available soft and hard data for the third quarter point to further improvements in private consumption although at a modest pace. Consumer confidence is on the rise, while retail sales are on positive upward trend, as confirmed by the increased recorded in July (see charts 2 and 3).

BY Clemente DE LUCIA

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