Euro Outlook 2011

Germany Outlook 2011 – Upswing getting broader
■ We expect the German economy to grow by 2½% next year after a plus of 3.6% in 2010.
More important than the sheer number is the composition of growth. The upswing has
been getting broader, with the positive impulses from exports carrying over into domestic
demand. According to our forecasts, total domestic demand will contribute 1½ percentage
points to overall GDP growth of 2½%.
■ Especially investment in machinery & equipment has picked up substantially. Furthermore,
companies' willingness to hire additional people jumped recently. For instance, the
employment subcomponent of  the Manufacturing PMI hit an all-time high last month.
Overall, there is plenty of empirical evidence that the German labor market – previously
known for its notorious sluggishness during upswings – is now transforming growth into
new jobs. The latest upbeat news from the labor market bode well for consumer spending
for two reasons. First, from a fundamental point of view, overall purchasing power is
increasing, finally leading to Mr. Average Citizen spending more money. Second, from a
psychological perspective, the feel-good factor is rising. After hitting record-high levels
during the global financial crisis, unemployment fears of private households have plunged
in the last few months. We expect private consumer expenditures to grow by 2% next year
and hence at the strongest pace in the last ten years.
■ Business expectations included in the Ifo index do not show any signs of fatigue yet.
Instead, they hit their highest level since the start of our time series in 1982. However,
given that other, even more forward-looking business cycle gauges like the OECD Leading
Indicator for Germany and EMU M1 growth have been pointing south for quite a while, we
are skeptical whether the upward trend is sustainable in the medium term. Given robust
but softening company sentiment across the globe, we expect German business
expectations to peak in the next couple of months.
■ In terms of fiscal indicators, Germany remains well on track. Besides the growth-driven
improvement in tax revenues, there will be austerity measures equaling 0.4% of GDP next
year, in order to comply with the debt brake. We expect the deficit to already fall below the
Maastricht threshold in 2011 after a comparatively low 3½% this year. However, public
debt will remain at elevated levels after the surge in 2010. The one-off effect of the creation
of public "bad banks" for WestLB and Hypo Real Estate assets lifted, at least temporarily,
the level of gross public debt by more than 10% of GDP.

France Outlook 2011  – Weighed down by structural drawbacks

■ We expect that France’s GDP will not accelerate in 2011, leveling off at 1.4% after 1.5%
this year. In the near term, we see two main factors preventing a stronger recovery in
domestic demand, which has always been the country’s main growth engine:
■ 1) Large spare capacity weighing on investment growth. The higher level of
synchronization shown by France with respect to its eurozone peers in terms of capacity
utilization/investment dynamic in this cycle (i.e. capacity and business investment plunged
together) suggests that we could expect a “normal” relationship between the two variables,
with a recovery in capacity utilization anticipating a firmer acceleration in investment. It is
worth highlighting that, according to business survey indications, limits to production are
mainly related to insufficient demand, whereas financial constraints do not seem to be
binding for non-financial firms, on average. The finding concerning the liquidity situation of
NFCs is consistent with the message from  the ECB’s Bank Lending Survey, which points
to favorable credit supply conditions in France. It  is also consistent with latest indications
by sector financial accounts, suggesting that the improvement in firms’ financial position
stretched into 2010.
■ 2) Likely stabilization of the pace of growth in disposable income, with a dampening effect
on private consumption. The dynamic of disposable income was supported by generous
automatic stabilizers throughout the crisis: it eased but remained positive, preventing
households from further reducing consumption. In fact, household consumption has been
accelerating moderately since early last year, also thanks to government incentives to
households for buying durable goods. Looking ahead, as relief from automatic stabilizers is
gradually fading, fiscal austerity measures are kicking in, and labor income recovers only
gradually, we think the recovery in household consumption will unfold at a moderate pace
(1.0% in 2011 vs. 1.5% in 2010). On a positive note, the steady rise in the household
savings rate since the onset of the crisis would provide households with a buffer against
fluctuations in income and allow them to smooth their consumption profile.
■ The draft budget for 2011 foresees a reduction in the deficit-to-GDP ratio from 7.7% to
6.0%, matching the projection originally penciled in for the 2010-2013 budgetary plan. The
government has revised down its 2011 GDP forecast from 2.5% to 2%, still leaning toward
the optimistic side. The bulk of the consolidation effort hinges on measures aimed at
controlling spending at sub-government levels, in addition to the withdrawal of fiscal
stimulus measures (worth EUR 18bn). The government restated its commitment to freezing
real spending at the central government level, notably through a further large cut in public
employment (by 32k, replacing only one in two civil servants that retire) and a EUR 10bn
reduction in tax expenditure (i.e. fiscal niches).

Italy Outlook 2011  – Fiscal discipline to remain on track

■ After having expanded by 0.3% qoq in 3Q, GDP growth in 4Q should decelerate slightly to
0.2% qoq, leaving our 1% forecast for 2010 on track. As far as next year is concerned, we
expect GDP growth to be only marginally stronger than in 2010, averaging 1.1% yoy. Apart
from a near-term correction due to the expiration of the “Tremonti-ter”, capex should remain
supportive for growth, benefiting of improving corporate sector’s fundamentals and rising
capacity utilization, while we expect investment in construction to resume (mildly) positive
growth as 2011 progresses. Consumption should continue to expand, but at a very soft
pace, while net exports contribution will probably be slightly positive.  
■ After having fallen during the summer, the unemployment rate was back on the rise in
September-October, confirming that the previous decline was  not genuine, but reflected
mostly an outflow of discouraged workers from the labor force. In order to see a meaningful
and sustainable decline in unemployment, job creation has to pick up significantly.
However, due to expectations of modest GDP growth, this is not our baseline scenario. We
expect the unemployment rate to average 8.6% next year, after 8.4% in 2010.  
■ CPI inflation should average 1.5% in 2010. In 2011, we expect headline inflation to
accelerate moderately throughout the year, averaging 1.9%. Upside risks to our inflation
outlook stem mostly from developments in energy prices and core inflation, which have so
far been a bit firmer than expected.
■ Early in December, both houses of the Parliament approved smoothly the Budget and
Stability Law for 2011, which did not bring meaningful changes to the path of fiscal
consolidation envisaged in the September  Public Finance Decision. The government
expects the deficit-to-GDP ratio to fall from 5% this year to 3.9% in 2011, 2.7% in 2012 and
2.2% in 2013. The fiscal performance so far this year leaves the government’s target on
track. In January-November, the state sector borrowing requirement, the timeliest indicator
of the fiscal performance, amounted to EUR 76.9bn, EUR 11.5bn (-13%) less than in the
same period of 2009. We are slightly less optimistic than the government for the next two
years: we expect the deficit  to fall to 4.3% in 2011 and to 3.3% in 2012. The government
envisages a debt-to-GDP ratio rising from 118.5% this year to 119.2% in 2011 (broadly in
line with our expectations), and declining to 117.5% in 2012 (slightly better than our
118.1%), and to 115.2% in 2013.
■ The political crisis was only partially solved by the confidence vote on December 14, which
gave Berlusconi a clear victory in the Senate but a very thin majority in the Lower House.
Berlusconi remains in office, but his ruling coalition has clearly lost its grip on power. The
scenario of an early election at some point next year cannot be ruled out. Still, Italy’s fiscal
discipline should remain on track as Mr. Tremonti has good chances to remain in charge of
fiscal policy. We see no downside risks for Italy’s sovereign rating.  

Spain Outlook 2011  – Slowly on the mend
■ The recovery in economic activity should continue but only at a moderate pace, as
austerity measures continue to bite, and private sector deleveraging is gaining momentum.
The unemployment rate will remain at very high levels.
■ We expect that GDP will grow 0.5% in 2011, after a 0.2% contraction this year. Net exports
should remain the main contributor to GDP growth, whereas final domestic demand should
continue to act as a drag, with an easing pace of contraction in gross fixed investment
accompanied by a substantial deceleration in private consumption. Investment growth
should remain in negative territory most of the year, reflecting the ongoing downsizing of
the construction sector (accounting for nearly 10% of GDP at the height of the boom, now
down to 4.6%) and a sizeable reduction in public investment with the aim to contain public
expenditure. On the other hand, the recovery in equipment investment tentatively observed
in the past few quarters, should gather moderate steam in the coming quarters.
■ After having contracted in 2010, employment  is forecasted to broadly stabilize next year.
The unemployment rate should peak at 20.7% by mid-year, and gradually decline in the
next few quarters. The unemployment rate should average 20.5% next year versus 20.2%
in 2010.
■ Harmonized inflation should remain resilient in the 2.2% area throughout the first half of the
year – mostly due to an increase in indirect taxes and sustained energy inflation – and
decline only moderately (and temporarily) at the beginning of the summer. We foresee
inflation averaging 2.1% in 2011, after 1.8% in 2010.
■ The Spanish government recently announced  privatization plans worth EUR 15-20bn
(1.5/1.8% of GDP), involving parts of the state lottery system and the airport authority, to
keep its pledge to reduce the budget deficit from 9.3% in 2010 to 6% in 2011. When
Spain’s 2011 Budget Law was presented to Parliament, we cautioned that the unveiled
fiscal measures fell short of meeting the deficit target, and that additional measures worth
1%-1.5% of GDP would be required. While more details are needed to assess the impact
of the new privatization plans on the 2011 deficit, we have become more confident in the
government’s ability to meet the target. The government is pursuing an ambitious but
credible fiscal adjustment to address the budgetary deterioration, which partly reflects the
evaporation of tax revenues that had been long considered as structural. The credibility of
the government's commitment is enhanced by the adoption of a new control mechanism on
autonomous communities’ spending, and a sketch of a long-overdue pension reform. 


Austria Outlook 2011  – Strong sentiment, strong prospects

■ The signs pointing to a continuation of the high pace of growth are still present towards the
end of 2010. The Austrian industrial sector is benefiting substantially from the rebound in
the emerging markets of Asia and Latin America, although this can primarily be attributed
to supplier relationships with the German economy, which is oriented towards the world
market. As a result, industrial confidence is at the highest level seen since the end of 2007.
Although the Bank Austria Purchasing Managers’ Index has already passed its all-time 
high, the current level of 55.2 points suggests that strong industrial growth will continue into 
the future. The ratio of order intake to inventories has risen again in comparison to the
previous months – a development that has been a sure sign of rapid industrial growth in
the past – and the order backlogs continue to grow.  
■ The industrial sector appears to have already passed the initial peak of the current cycle,
so the upward trend in the sector will lose some of its momentum in the coming months. In
2011, industrial growth will remain somewhat below this year’s increase of around 6% due 
to the slowdown of the global recovery. However, the industrial sector (and from a
demand-side perspective, exports) will remain the driving force behind the Austrian
economy. Our forecast for 2011 as a whole still calls for GDP growth of 2.0%, compared to 
1.9% in 2010. 
■ The service sector will continue its stable upward trend at a slightly slower pace in 2011.
This development is being supported by the fact that consumption growth is easing 
somewhat, which led to a moderate deterioration of sentiment among domestic consumers 
in November. Since pro-capita income is not increasing in real terms, this slightly slower
upward trend will primarily be supported by  the favourable development of employment.
After rising by 0.7% this year, employment is still expected to increase by 0.6% in 2011. At 
4.8%, the unemployment rate was amongst  the lowest in the EU in November, and 
unemployment is expected to continue to fall to an annual average of 4.4% in 2011. 
■ Inflation was fairly subdued again in October, coming in at 2% in year-on-year terms. On 
the one hand, higher prices for agricultural goods on the global markets led to rising prices
for food and clothing. On the other, the prices for many services and consumer durable 
goods are still very low. The lack of cyclical inflation is being reflected in this development. 
We therefore expect to see a stable inflation rate near the 2% mark in the coming months; 
however, this will be highly dependent on external price influences.  
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Full report: Euro Outlook 2011