eurozone economics update: recovery remains volatile… 2q17 ... · the eurozone could become the...

Eurozone Economics Update: 2Q17 April 2017

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Eurozone Economics Update: 2Q17 First signs of relaxation

Eurozone 24 April 2017

Recovery remains volatile…

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…while inflation picks up…

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Political risks are slowly ebbing away, bringing economics and growth back to the forefront in the Eurozone. The Eurozone could become the positive growth surprise of the year as the cycle is benefiting from low interest rates, a weak euro and stronger domestic demand. This positive outlook should enable the ECB to gradually move towards tapering. Even though with ongoing geopolitical and also domestic political risks, signs of relaxation should not be mistaken for signs that everything is rosy.

As so many new years in the past, the year 2017 in the Eurozone started off on a positive footing. Sentiment indicators have continued to improve, pointing to a continuation and even an acceleration of the current recovery. Contrary to earlier years, in which hard data could never fully match optimistic soft data, there is more and more evidence that this year could finally see a strengthening and broadening of the Eurozone recovery.

Currently, the Eurozone recovery is no longer driven by a few member states but by almost all member states; at least judging from a cyclical perspective. Domestic demand has become an important growth driver and the weak euro exchange rate is supporting the export sector. Also, loan growth is finally showing tentative signs of a positive reaction to the ECB’s ultra-loose monetary policy. If and when political uncertainty in the Eurozone, particularly after the second round of the French presidential elections, should ebb away, the Eurozone economy could even become the growth surprise of the year.

Before getting too enthusiastic, not all is well in the Eurozone. Despite the cyclical upswing, unemployment rates (and above all youth unemployment rates) in many countries remain far too high to reduce social inequality, government debt ratios have hardly come down in most countries and further, and necessary, works on the structure of the monetary union have been put on hold. In particular the latter remains of high importance, given the fact that the current (institutional) set-up of the Eurozone will probably not be sufficient to tackle another severe economic crisis.

In this balancing act of cyclical recovery but still unsolved fundamental issues, the ECB’s tasks will increasingly become more difficult. While on the one hand, the risk of deflation has clearly disappeared and some normalisation of policies could be considered, still high government debt and the fragile institutional set-up do hardly allow for a quick and clean exit from ultra-loose policies. This is why we expect the ECB to only very gradually move towards tapering. As regards the issue of sequencing, we currently still expect the ECB to first end QE before deciding on a first rate hike. Even though some tweaks to the deposit rate before the official end of QE should not be ruled out entirely.

The more optimistic outlook is also reflected in our country forecasts. While Germany (p. 6) is only preparing for the upcoming elections, France (p. 8) should soon be able to shift the focus from politics to economics and accelerate reform efforts. In Italy (p. 10), the risk of snap elections has faded away but slow growth and high debt are still an explosive mix. Spain (p. 12) and the Netherlands (p. 14) are clearly one of the fast growers in the Eurozone this year. It will be interesting to see what the economic preferences of the new Dutch government will be. Finally, Belgium (p. 16) is also surfing the way of modest to moderate growth.

Peter Vanden Houte Chief Eurozone Economist Brussels +32 2 547 8009 [email protected]

Eurozone Economics Team

ECONOMICS

GLOBAL MARKETS RESEARCH

research.ing.com SEE THE DISCLOSURES APPENDIX FOR IMPORTANT DISCLOSURES & ANALYST CERTIFICATION


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Contents

Eurozone 3

Recovery gathers pace (but can it last?) ............................................................................ 3

Germany 6

Endless cycle ..................................................................................................................... 6

France 8

New political landscape ahead ........................................................................................... 8

Italy 10

Low risk, for now .............................................................................................................. 10

Spain 12

Keeping up the pace ........................................................................................................ 12

Netherlands 14

Stronger for longer ........................................................................................................... 14

Belgium 16

Cautiously improving ........................................................................................................ 16

Other Eurozone countries 18

Eurozone housing markets 21

ING’s economics forecasts 22

Disclosures Appendix 24


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Eurozone

Recovery gathers pace (but can it last?)

The Eurozone recovery is now outpacing the US and the political risk has remained contained until now, with elections in Italy not expected before 2018. Inflation fell back after a temporary blip, thwarting speculation of a possible early ECB rate hike.

The last few months have seen important swings in market expectations. Whereas until the end of 2016 the general feeling was that a subdued recovery with a lot of political risks, would keep the ECB in easing mode for the foreseeable future, this started to change in the course of the first quarter of this year. All of a sudden markets were abuzz with speculation on the possibility of an early rate hike in the Eurozone, after a member of the ECB’s Governing Council, Nowotny suggested the feasibility of a deposit rate hike before the end of the QE programme. Only after several verbal interventions of members of the ECB Board speculation cooled down again.

Fig 1 Economic data still better than expected

Fig 2 Consumer drives the recovery

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That said, one can easily understand why markets had started to pencil in the possibility of a change in monetary policy in a not too distant future. Economic data have been surprising to the upside. The flash composite PMI rose to its highest level in 6 years in April, while the European Commission’s business climate indicator stabilized at 0.82 in March, the highest level since 2011. While not all hard data are as positive (e.g. industrial production was rather weak in February), we see certainly an upward risk to our forecast for the first half of the year. Indeed, consumption seems to be well supported. The upturn in employment led to a decline in the savings ratio, supporting consumption throughout 2016. This is likely to continue, even though the somewhat higher energy prices are no longer contributing to the increase in real disposable income. In February the volume of retail sales climbed by 0.7% month-on-month, after a 0.1% increase in January. With consumer confidence surging in April to the highest level in 2 years, consumption expenditure has likely started the second quarter on a strong footing. Construction, which has long been the Achilles’ heel of the European recovery, is now also on a roll. Both the sentiment indicators for activity and new orders are now significantly above their long term averages, signaling a positive growth contribution from construction this year.

Speculation on an early end of QE… …has been quelled

Strong sentiment figures in 1Q 2017…


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The €-coin indicator, an estimate of the underlying GDP growth pace, averaged 0.72% in 1Q, showing that the Eurozone economy started the year on a strong footing, outpacing US growth. Without political mayhem, a 2% growth figure should be within reach, though we prefer to remain on the cautious side. That said, we are now estimating 1.7% growth both for 2017 and 2018.

After all, the political hurdles might not be as big a drag on growth as one might have feared. In the Netherlands, the far-right Freedom Party obtained a good result, coming in second, but the party of Prime Minister Rutte remained with a solid margin the biggest party. Meanwhile a new agreement has been reached regarding Greece’s bail-out, most likely also keeping the IMF on board, even though there will not be an early debt write-down. In Germany, the elections seem to be a contest between the two big traditional parties, with populists playing an only marginal role. In France the centrist candidate Emmanuel Macron came out first in the first round of the presidential elections and is the favourite to win against Marine Le Pen in the second round, though voter turnout could still cause a surprise. More important in our view is the fact that in Italy early elections are now off the table, meaning that parliamentary elections are most probably not foreseen before the first quarter of 2018. While this takes away some of the short-term political risk, the longer term risk has not disappeared at all. The Italian political landscape and electorate has, in the wake of the dismal growth performance of the last 10 years, become increasingly disillusioned with the euro and the European Union at large. The Italian elections are therefore far more dangerous for the stability of the Eurozone than the French or German elections.

Fig 3 Stabilising oil price pushes down inflation

Fig 4 Excess liquidity keeps short rates negative

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Meanwhile Target2 imbalances are on the rise again, potentially signaling capital flight out of the weaker member states (as Target2 balances represent the booking of international capital flows within the Eurosystem). The German Target2 surplus is now at higher levels than at the peak of the euro-crisis in 2012. However, as the BIS explained, this is to some extent the consequence of the ECB’s QE programme. When, eg, the Banca d’Italia buys Italian governments from a foreign bank, a Target2 imbalance arises. As many non-Eurozone banks connect to the ECB’s Target2 system via a German correspondent bank (60% of all Eurosystem bond purchases happens via banks that are connected to the Target2 system via the Bundesbank) and the money stays on a bank account in Germany, then the German Target2 surplus increases. So for the time being, this doesn’t reflect growing tensions within the Eurozone, though in case of break-up it would of course constitute a problem.

…suggesting above 0.5% quarterly GDP growth

Dutch elections didn’t result in a populist victory… …while in France the result of the first round of the presidential elections was comforting Italian politics could still produce an upset

Target2 imbalances have been rising again… …but largely on the back of QE bond purchases


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As for inflation, the HICP inflation has fallen back below 2%, reaching a lower-than- expected 1.5% in March. Although some of the decline is due to calendar effects (the timing of the Easter holiday period), headline inflation is likely to remain 2% throughout the year, now that energy prices have stabilized. Core inflation remains stubbornly below 1%. While most surveys indicate that pipeline inflation is picking up, there is little reason to believe that core inflation will rise above 1.5% over the next 12 months.

In that regard the ECB has no reason to change its monetary policy. In his address to the ECB watchers conference, Mario Draghi made it very clear that as far as inflation is concerned, there is still little evidence that underlying inflation is in an upward trend. For this to happen, one should see a more convincing upturn in wages, something that has remained largely absent in the current recovery.

On top of that, with Italian elections in the first half of 2018, it will be difficult for the ECB to withdraw stimulus at a moment of potential tension within the Eurozone. We therefore stand by our call that QE will be extended for another 6 months (albeit with some tapering), while the deposit rate is to be increased in the second half of 2018 at the earliest. The ECB could start hinting at a very gradual exit already in the months after the French elections. Only if the ECB would come to the conclusion that the negative deposit rate hike is actually constraining credit growth (as it can be considered as a tax on the banks) and markets would only interpret it as a pure technical move and not the start of a normalization cycle, an earlier move (i.e. deposit rate hike before the end of QE) could be possible. However, that is not our base case. With Mario Draghi claiming that the impact of negative rates on bank profitability has been offset by the positive side-effects of easier financial conditions, it looks indeed unlikely that the ECB would come back on its forward guidance, expecting interest rates “to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases”.

Eurozone banks have enthusiastically taken advantage of the last TLTRO to collect cheap funding with a 4 year maturity. This has, however, increased excess liquidity in the money market even further, something that is likely to keep money market rates close to the deposit rate for some time to come, ie, in negative territory.

Volatility in the bond market has also been quite important over the last 6 months. With the US economy growing somewhat slower than expected and the ECB having succeeded to suppress the speculation of an early rate hike, bond yields have fallen back about 30bp from the levels seen in the first quarter. This volatility is likely to remain in a moderately upward trend, though a more significant increase seems unlikely before the ECB begins its exit strategy.

Fig 5 The Eurozone economy in a nutshell (%YoY)

2015 2016F 2017F 2018F

GDP 1.9 1.7 1.7 1.7 Private consumption 1.8 1.9 1.7 1.6 Investment 3.0 2.5 1.7 2.6 Government consumption 1.3 1.8 1.3 1.3 Net trade contribution 0.2 -0.2 0.1 0.0

Headline CPI 0.1 0.3 1.5 1.4 Budget balance (% GDP) -2.1 -1.7 -1.7 -1.6

Refi rate (eop) 0.05 0.0 0.0 0.0

Source: Thomson Reuters, all forecasts ING estimates

Peter Vanden Houte, Brussels +32 2 547 8009

Inflation fell back below 2%...

…vindicating the ECB’s determination to continue its easy monetary policy

Exit strategy likely to be announced in the run-up to the German elections

Bond yields remain volatile in a moderately upward trend

Excess liquidity remains abundant


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Germany

Endless cycle

Despite continued political uncertainty in many important trading partners, the German economy is enjoying yet another growth revival.

The German economy remains the showcase of the Eurozone. Even in the 9th year of an almost non-stop expansion with only three quarters of negative growth since 2009, economic growth is still amongst the highest of all Eurozone countries. Euro crisis, financial market turmoil, Chinese slowdown, Brexit or Trump. None of the recent major global events was able to derail, not even to slow the economy. The transition towards more domestically-driven growth came at the right time to shield the German economy against external events. Since 2012, private consumption has on average contributed around two-thirds of total GDP growth. Now, although the structural reforms of the past have long been worn off, the ultra-loose monetary policy of the ECB with low interest rates and a weak euro combined with higher government consumption on the back of the influx of refugees are artificially extending the current golden cycle.

Currently, even the weak spot of the last years – investment and industrial production –shows tentative signs of a revival. Even though capacity utilisation in the industry is still only marginally above its historical average and clearly below the last peak in 2007 and 2008, inventory reduction, as well as the fact that equipment as a limiting factor to production, is currently regarded as being at its highest level since the beginning of 2014 bode well for the coming months. Also, loans to non-financial corporates have finally started to pick up since the start of 2016, currently growing at almost 3.5% YoY.

Fig 6 Confidence still on the rise…

Fig 7 …while weather impact should melt away

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Another way to support domestic investment would be to receive the current international criticism on the German trade surplus in a more elegant and reflective way. As regards that criticism, it is hard to deny that German exporters are one of the main beneficiaries of the weak euro exchange rate, even though the German government is clearly the wrong address for criticism on a weak euro. Roughly two-thirds of all German exports go to non-euro countries. The weak euro and surging German exports is more than a coincidence. However, there is very little the German government could do to weaken exports. Instead, the government should focus on the import side of the trade surplus. Here, stronger domestic demand, preferably in the form of higher private and public

Positive cycle enters yet another upswing…

…and even investments are showing tentative signs of improvement...

…while International criticism of trade surplus should be received more elegantly…


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investments, should gradually help reducing the trade surplus. Eventually, if treated correctly with investments in the growth potential of the German economy, a shrinking trade surplus is mainly in the interest of Germany itself.

Against the background of a strong economy, one could think that the economy is very unlikely to become a dominant topic during the upcoming election campaign. Wrongly so. Angela Merkel’s challenger, Martin Schulz, has already suggested reversing parts of earlier reforms. Schulz has also started to criticize the downsides of the current recovery. In the upcoming election campaign, Germany will now probably experience an almost ironic controversy on the reforms of the 2000s. Merkel and the Christian-democrats will defend the reforms and point to the current strength of the economy, even though they were in the opposition back then. At the same time, Schulz and the Social-democrats will have to explain to the voters why they now want to reform the reforms, even though they have been part of the government in 16 out of the last 19 years.

Fig 8 German economy in a nutshell (%YoY)

2015 2016F 2017F 2018F

GDP 1.5 1.8 1.5 1.5 Private consumption 1.9 1.7 1.0 1.0 Investment 1.1 1.9 0.9 2.5 Government consumption 2.8 4.3 3.6 1.4 Net trade contribution 0.1 -0.2 0.0 0.1

Headline CPI (%) 0.1 0.4 1.7 1.7

Unemployment rate (%) 4.3 4.1 4.2 4.3 Budget balance as a % of GDP 0.5 0.6 0.3 0.0 Government debt as a % of GDP 71.1 69.0 67.1 64.9

Source: Thomson Reuters, all forecasts ING estimates, unemployment rates according to national definition

To many observers, the campaign could sound like two tales of one economy. Unfortunately, a third tale is needed to maintain Germany’s status of “strong man of Europe.” However, no one has yet addressed the real economic challenge: too few new structural reforms. Instead of twisting about the glamour and dark sides of the current Wirtschaftswunder, the next government should start preparing the next Wunder. For this, new reforms and investment are the right way forward.

While the labor market is one of the showcases of the current growth performance, some adjustments to the low-wage sector in order to get a broader base for domestic demand do make sense; not necessarily via transfers but possibly also by further reforms. Currently, the labor market still has several built-in hurdles to further employment. Just think of tax disincentives for second earners.

Another issue is the above-mentioned lack of investment. While government spending on infrastructure has increased since 2015, more will be needed. Not only to improve an ageing logistical and traffic infrastructure but most of all to face the challenges of digitalization. Currently, digitalization (or Industry 4.0 as it is called in Germany) is mainly a means to provide new technologies and improve cost efficiency but to a much lesser extent a means to explore new services or distribution channels. Investments in for example the roll-out of broadband internet but also further high-speed technologies will be needed to safeguard Germany’s leading role. Let’s not forget that a higher investment ratio does not necessarily have to come from more public investments.

Despite the fact that the reforms of the 2000s have become an issue in the campaign, up to now, the biggest political parties have not yet addressed the economic issues which probably matter most: investments and structural reforms. Still, Bill Clinton’s “it’s the economy, stupid” could yet dominate the German election campaign this year.

Carsten Brzeski, Frankfurt +49 69 27 222 64455

Despite sound fundamentals, election campaign will also see economic issues high on the agenda…

…even though the real topics have not been mentioned, yet,…

…as labour market needs further reforms…

…and investments into future-oriented sectors could increase growth potential…

…while pure discussion on 2000s reforms would be short-sighted


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France

New political landscape ahead

We believe that a victory of the centrist presidential candidate will bring a confidence boost, slightly higher growth for 2018 and 2019, and more public investment. Nevertheless, as this political formula has yet to be tested, we see risks to political stability in the short run, depending on the results of the 18 June legislative elections.

For the first time of the Vth Republic, the President will not come from the traditional left or right. With the lead that Mr Macron has for the second round, he looks as the most likely next French President. However, with his party being less than two year old, we think it is unlikely that it will have a governing majority after the June legislative elections. He will therefore have to find bipartisan majorities for his future reforms, a formula yet to be tested, potentially increasing political instability. However, he will have a strong mandate for reforms: with more than 40% of the population ready to support extremist parties from the left or right, it is time for a change.

Looking at confidence indicators gives some assurance that the current – still weak – positive economic cycle remains on the right track in France and that GDP growth will remain positive. French GDP indeed recovered in 2015 and 2016, with annual growth rates of respectively 1.2% and 1.1% (after an average of 0.5% in 2012-14). This remains weak and insufficient to prompt strong employment growth. Most of this growth is coming from domestic demand, which has recovered more strongly than expected in 2016 on the back of higher consumer confidence and a stabilizing housing market. Looking at the different components of domestic demand, one sees that, private consumption was the main growth engine, while investments started to contribute again positively to growth in the second half of 2016.

Private consumption primarily rebounded in 2015 on the back of lower oil prices (lower oil prices was a boost of around 0.9% of total private consumption, or 0.5% of GDP in 2015). This effect slowly faded in 2016 but unemployment began to stabilize, helping a further recovery in consumer confidence, which is now at its highest level since 2007. This could support private consumption growth in 2017, but for it to be sustained, higher employment growth is needed. On that front, we believe that Mr Macron’s program, with growth supportive fiscal measures, both for households and companies, together with structural reforms could bring a growth acceleration.

Besides, it looks as if the set of investment supporting measures decided in recent years by the government have been making their way into French companies. Corporate investments are indeed 3% above their pre-crisis level, and posted a strong 4.3% growth in 2016. It is therefore hard to support the fact that these measures have been ineffective and that the country needs more business investment. Meanwhile, public and households’ investments are still respectively 17% and 12% below their pre-crisis levels. A recovering housing market should bring some recovery to the second one while more public investment seems in the offing. The prospects on that side therefore are rather positive.

We currently expect total investments to continue to recover, by 2.1% in 2017 and 3.2% in 2018 while private consumption growth could slow down from 1.8% in 2016 to 1.4% in 2017 as new measures will take time to boost employment growth. Private consumption growth should accelerate to 1.8% in 2018. The public investment intentions of Mr Macron could certainly help them to recover to their pre-crisis level and support the recovery.

France is set for a change…

… but the French recovery remains weak… …which hides a stronger than expected domestic demand recovery

Private consumption still needs more support from employment growth

Business investments have fully recovered, but housing and public investments still have a long way to go


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Fig 9 Domestic demand has been recovering

Fig 10 Unit labour costs are lower in France, but elsewhere as well (% change: 2012-16)

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All in all, domestic demand is therefore on the right track. This growth outlook is however darkened by the negative contribution of external trade (which took off almost a full percentage point of growth in 2016), which is the main reason why our growth outlook is limited to 1.3% in 2017 and 1.7% in 2018 in our baseline scenario (which supposes a Macron victory). However, with the Eurozone recovery now back on track, external demand should increase while the weak euro should boost exports at least in the first half of the year. Structural reforms that would increase France’s competitiveness (unit labour costs for example remain elevated in international comparison) would contribute to reinforce this trend, we therefore expect net exports to contribute much less negatively to GDP growth in 2017 and in 2018 (-0.1ppt each year).

Fig 11 French economy in a nutshell (% YoY)

2015 2016 2017F 2018F

GDP 1.2 1.1 1.3 1.7 Private consumption 1.5 1.8 1.4 1.8 Investment 0.9 2.8 2.1 3.2 Government consumption 1.4 1.5 1.3 1.7 Net trade contribution -0.3 -0.9 -0.1 -0.1

Headline CPI 0.0 0.2 1.4 1.6 Unemployment rate 10.4 10.1 9.8 9.2

Budget balance as % of GDP -3.5 -3.3 -3.2 -3.0 Government debt as % of GDP 96.2 96.4 97 97

Source: Thomson Reuters, all forecasts ING estimates, unemployment rates according to ILO definition

Nevertheless, as a centrist government formula has yet to be tested, we see risks to political stability in the short run (depending on the legislative elections’ results) that could dampen this outlook. Yet, for now, there are still reasons to be positive.

For the second round, the first polls indicate that Mr Macron would reach 62-64%. A victory of Ms. Le Pen is an unlikely event, but no doubt she will try to attract voters from Mr Mélenchon on the basis of their assumed preference for an anti-globalisation programme and of the perspective of a radical overhaul of the European treaties. In any case, the task for the new president will not be easy with a likely fractioned National Assembly that calls for difficult negotiation and compromises. We are not there yet as 2 elections are still to be held: round 2 for the presidential on 7 May and legislative on the 11 and 18 June.

Julien Manceaux, Brussels +32 2 547 33 50

We expect a moderate acceleration in the French recovery… …but improving competitiveness could make this quicker

Macron is expected to become president… … and his task to be particularly difficult


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Italy

Low risk, for now

The risk of a 2017 snap election is now markedly reduced, but political tensions might re-emerge during the budget season.

The timid recovery of the Italian economy softened a bit in 4Q16, when growth expanded at a 0.2% quarterly pace (+1.0% YoY). The demand breakdown confirmed that a re-balancing was in the making: private investment became the first YoY growth driver (0.7% contribution), followed by private consumption (0.6% contribution), and by public consumption (0.2% contribution). Net exports were almost growth neutral (-0.06% contribution), while inventory accumulation confirmed a drag on YoY growth with a 0.4% negative contribution.

Data evidence for 1Q17 has been puzzling, but our overall assessment is that the recovery remains in place. On the one hand business confidence data posted convincing increases, both in manufacturing and in service sectors; on the other hand hard data have come in disappointingly weak. Industrial production turned out particularly volatile, with the sharp January contraction only partially compensated by the February rebound.

On the consumption front, the picture was more consistent, with the modest decline in consumer confidence matched by soft-ish retail sales data. On the back of developments in the labour market and on the inflation front, some softness in private consumption is to be expected in 1Q17. Preliminary Istat labour market data show that over the Nov-Feb period employment growth stabilized at 1.15% YoY, with the 3M/3M increase increase fully explained by temporary employees. Apparently, the phasing out of tax incentives for open ended hirings is now fully showing up in the data. With wage growth close to its historic low at 0.5% YoY, in 2016 employment remained the main engine of nominal disposable income. A low inflation spell (inflation averaged -0.1% in 2016) helped boosting households’ real disposable income. However, in 1Q17 HICP consumer inflation has averaged 1.3%, eating into real disposable income, and possibly weighing, at least temporarily, on private consumption.

Fig 12 Growth rebalancing continued

Fig 13 Spread resilient to reduced snap election risk

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In the meantime, gross fixed capital formation could be benefitting from tax incentives introduced by the budget, offsetting softer consumption. We are not expecting a major

Rebalancing continued in 4Q16 GDP growth pattern

Timid growth should remain in place in 1Q17…

...with private consumption temporarily under pressure...

...possibly compensated by private investments


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shift of gear in private investment, though. Lending activity to non-financial corporations has continued contracting (if at a decelerating pace) and, according to the latest BLS published in January, banks expected no acceleration of demand for loans. The other reason which suggests some caution relates to the persistence of the political risk.

To be sure, the latest political developments have reduced the risk of early elections in 2017, but this has so far failed dissipating market concern. If in principle the January ruling of the Constitutional court on the electoral law of the Senate, had created a viable setting for an early election, subsequent developments, chiefly the split of the ruling PD party, have worked the other way round. The side effect of the split was shifting the PD into the second position in electoral opinion polls, tracking the 5SM by a c.3pp margin. Not a strong incentive to rush to the polls. Since then, domestic political developments have been relatively smooth, as if involved parties had finally come to terms with the idea that the current legislature will have to end in Spring 2018, its natural maturity. So far, no serious effort has been made to approve a new electoral law enhancing governability, as requested by president Mattarella. Things might change after 30 April, when the PD will hold its primary elections for the new leadership, which have the former PM Matteo Renzi as the forerunner. Once the PD will have a new leadership, things will likely move faster, possibly putting extra pressure on the PD-led Gentiloni government.

When crafting the next budget, the Gentiloni government will likely be feeling the pressure of its stakeholders, which will be tactically positioning themselves in view of the 2018 election. So far it has managed to confirm its commitment to fiscal discipline, bowing to the EU request for a mini budget worth 0.2% of GDP, but not without tensions between ministers and backing political parties. The Economic and Financial document (DEF), recently disclosed, remained fairly vague on the next measures: it confirmed the ambitious planned deficit target for 2018 at 1.2% of GDP (from an estimated 2.1% in 2017), under the assumption that some €19.6bn worth of VAT hikes (the so called safeguard clauses agreed with the Commission) will be activated. The sole perspective of raising VAT provoked a cross-party uproar and some government back-pedaling. As it has been done over the last three years, the relevant sums will have to be recovered through alternative financing means and, we suspect, partly in deficit if some form of flexibility will again be conceded by Brussels. What seems clear is that under the current growth assumptions, there will be very limited scope for tax cuts, if any. The government will have to move within a narrow path, selectively targeting scarce available funds.

Interestingly, in the DEF the government acknowledged that the debt sustainability might start becoming an issue already in 2018 if the ECB will end its QE programme. In the medium run, with a rising cost of debt, consistently bringing the debt/GDP ratio on a declining path will call for a combination of continued fiscal discipline (higher primary surpluses) and stronger economic growth. For the latter to materialize, a stronger drive for reforms will be of the essence. A useful reminder, particularly in a pre-election year.

Fig 14 Italian economy in a nutshell (%YoY)

2015 2016F 2017F 2018F

GDP 0.7 0.9 0.8 0.9 Private consumption 1.6 1.3 0.8 0.9 Investment 1.4 3.1 3.1 2.1 Government consumption -0.7 0.6 0.6 0.5 Net trade contribution -0.4 -0.1 -0.1 0.0

Headline CPI (%) 0.1 -0.1 1.3 1.3

Unemployment rate (%) 11.9 11.7 11.6 11.3 Budget balance as a % of GDP -2.7 -2.4 -2.3 -2.1 Government debt as a % of GDP 132.1 132.6 132.9 131.7


Paolo Pizzoli, Milan +39 02 552 26 2468

Domestic politcal developments no more conductive to 2017 snap elections

Tensions might resurrect during the budget season... ...as budget constraints will leave a very limited scope for tax cuts ...making life harder for parties positioning for the upcoming elections.

Reforms even more essential, as debt sustainbility debate will be revamped by the perspective of an end of QE


12

Spain

Keeping up the pace

Economic momentum is steady and we expect growth to exceed the Eurozone average by 1ppt. That said, political risks have not disappeared.

Spanish GDP gets closer to its pre-crisis level and if GDP growth continues at the current pace, the threshold should be reached at mid-year. Both the IMF and the OECD praised the country for its “impressive recovery”, and even if some signs of slow down are popping up, it remains limited. In 2016, Spain went through a murky political year and most analysts expected a sharper decrease of the pace of recovery. However, GDP forecasts for 2016 had been progressively revised upwards: from 2% in April 2015 to 3.1% in October 2016 by the IMF, (the final reading was 3.2%) mainly on the basis of strong job creation. Even if soft indicators displayed relatively high volatility, domestic demand kept on improving strongly, leading the recovery to remain steady.

Fig 15 Reduction of spare capacity

Fig 16 Number of exporting firms (100 = 2006)

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Number of exporting firms Regularly Exporting firms

Source: DG ECFIN, INE Source: ICEX. (* 2017 is based on January data)

The private sector was the main engine of the GDP growth in 2015 and 2016 and survey-based indicators remain upbeat. Looking first at the business confidence (assessed by the national institute of statistics, INE), the recovery seems widespread across the different sector in 1Q. Even in the construction sector, the share of companies that are optimistic for the coming quarter exceed the share of pessimistic ones. As a consequence, hiring prospects are brightening and 12% of the respondents consider that employment will increase this quarter while only 8.5% think that it will decrease. Whereas this balance is now positive, it was neither the case in 1Q nor in 2Q last year. Looking then at consumer confidence, the perception is also improving despite the fact that consumers had remained broadly pessimistic since the financial crisis of 2007. According to the survey from the CIS, in March 61% of the respondents suggested that the general economic situation in Spain was bad or very bad, against 74% in March last year. The more positive evaluation also concerns personal issues: 29.6% of the respondents said that the lack of a job was their major current problem while they were 37.4% in March last year. The evolution of the labour market and the fast reduction of the unemployment rate are expected to be the front-page topics over the next two years. In our view the unemployment rate (at 21% in 1Q16) should gradually decline from 18% currently to 17% at the end of the year and could reach 15% by the end of 2019.

The recovery is impressive and withstands political instability

Both consumer confidence and business confidence keep on strengthening… … on the back of dynamic job creation… … and a reviving construction sector


13

Looking ahead, the positive momentum is expected to continue and Spain to deliver strong GDP figures, thanks to a reduction of spare capacity. In particular, the construction sector is expected to become a growth-driver. The total number of underemployed workers was at its lowest level since 2005 (when the indicator was first published). While 15.3% of the workers in the construction sector claimed to be underemployed in 3Q13, this figure was only at 7% in 4Q16 (the lowest figure since the 2007/08 financial crisis). In parallel, in 2016, the utilization rate in the manufacturing sector exceeded its historical average and is even approaching its pre-crisis level. Combining those facts to the hotel occupancy rate that broke its record last year, we foresee new investments in real estate and remain positive for the construction sector in 2017 and 2018.

A key growth driver that has emerged since 2010 is the external sector. The number of exporting firms had increased by 40% between 2010 and 2017. Exports of goods and services represented 33% of GDP in 4Q16 (imports: 28%) against only 27% in 4Q10 (imports: 27%). Exports of services benefit from the booming tourism sector. The development of a more export-led industry remains widespread and is based on past structural reforms, reduction in labour costs, productivity gains, attraction of multinational firms, and the weakness of the euro. Contribution of net trade to real GDP growth has been positive since 2016 and prospects are encouraging for 2017 and 2018.

Even with an effective government, politics remains at the forefront with Catalonia stepping up its independence project. The regional parliament approved a draft budget which included €5.8m for the organisation of a referendum in 2017. Catalonian leaders keep on thinking (wrongly?) that the membership to the EU is an established fact and only an administrative matter. At the end of the day, a desconnexió would lead to economic losses for both sides, but the question seems now beyond those concerns. To defuse the bomb, M. Rajoy undertook a stick and carrot approach by initiating legal proceedings for any move from Catalonian leaders and by offering an investment plan (€4.2bn by 2020). Standpoints continue to appear irreconcilable, making a solution satisfying both sides all but impossible

Finally, in Brexit talks, the question of Gibraltar is negligible from an economic point of view. Gibraltar’s GDP represents 0.1% of Spain’s GDP and a large share of the business could move to Malta if the region falls under Spanish law. The issue seems touchy for British tabloids but it is not for economists.

All in all, our projections remain upbeat for Spain in 2017 and the positive development of the labour market should boost consumption while exporting sectors should benefit from the accumulated competitive gains. We expect GDP growth to reach 2.7% in 2017, 1ppt above the Eurozone average. That said politics could still jeopardize the recovery, this time not at the national level but rather at the regional or international levels. Fresh regional financial means could turn out to be insufficient to solve the Catalonian issue while protectionism threat could hurt the growing exporting sectors.

Fig 17 Spanish economy in a nutshell (%YoY)

2015 2016 2017F 2018F

GDP 3.2 3.2 2.7 2.3 Private consumption 2.9 3.2 3.1 2.5 Investment 6.0 3.1 2.3 2.5 Government consumption 2.0 0.8 2.4 1.5 Net trade contribution 0.0 0.5 0.5 0.3

Headline CPI (%) -0.6 -0.3 2.1 1.6


Source: Thomson Reuters; all forecasts ING estimates

Geoffrey Minne, Brussels +32 547 33 86

Spare capacity is decreasing … … both in the manufacturing sector and in the construction sector

International competitiveness of Spanish companies has improved… … and the number of exporting firms has increased

Politics remains a sword of Damocles… … as the Catalonian government is planning a referendum for this year

Gibraltar should not be considered as an economic issue

Prospects remain positive even if political risks remain


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Netherlands

Stronger for longer

The economy remains on a firm growth trajectory, with risks slightly skewed to the downside related to geopolitical headwinds.

The general elections are over, the votes have been counted. The Netherlands did not turn out to be the next ‘populism domino’ to fall. Prime Minister Rutte got fewer seats than in 2012, but still won with a wide margin. Wilders' Freedom Party (PVV) got four more seats in parliament than 5 years ago, but the landslide win the polls alluded to in the run-up did not happen.

The VVD (Liberals), CDA (Christian Democrats), D66 (Democrats) and GroenLinks (Greens) have commenced talks to form a coalition government. Given the Dutch experience it could easily take many more weeks, or months, before a new government will take office. From an economic point of view, there is no need to rush. After two years of above-average growth, the economy is not showing any signs of slowing its pace. Brexit is not (yet) having a significant impact. In fact, exports are humming along just fine.

Our previous forecasts pencilled in slightly weaker growth for this year, but domestic and export dynamics are stronger than anticipated and the economy is now projected to grow at the same rate as in 2016: 2.2%. This will make it the 3rd consecutive year of 2% or higher growth. Consumption is the main driver. At the moment, consumers view it the best time in over 15 years to make large purchases.

Fig 18 Best time for large purchases in over 15 years Fig 19 Strong improvement in fiscal outlook

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Source: Macrobond Source: Statistics Netherlands, CPB, ING calculations

Sector-wise, construction will snatch the award for fastest growing sector for the third year running. However, the pace of expansion is easing. The low number of new building permits is becoming a bottleneck. Local authorities are having a difficult time to quickly process submitted building plans. Supply of existing homes is falling rapidly and is now as low as it was in 2008. Less than 3% of the total stock of owned houses is currently being put up for sale (at the peak it was 5.5%). With record high demand for homes, prices are set to increase by another 5 to 6% this year. Compared to pre-crisis levels, most regions still have ample room for further increases, but in Amsterdam the foundation for significant price increases is eroding. Affordability is deteriorating rapidly and demand – relatively strongly driven by capital flows from parents and investors – is more prone to shocks than in the rest of the Netherlands. That said, the mixture of strong demand and

No rush to form a new government…

…as the economy is still steaming ahead

GDP growth of 2% or higher for third year in a row... …helped by stronger consumer demand

Construction grows fastest, but housing will throttle back Foundation for significant prices increases is eroding in Amsterdam

https://www.ing.nl/media/pdf_EBZ_Amsterdam-real-estate-prices_tcm162-123899.pdf

https://www.ing.nl/media/pdf_EBZ_Amsterdam-real-estate-prices_tcm162-123899.pdf


15

supply at just 1.3% of the stock means prices could as easily continue to rise further in the next few years.

GDP growth is not solely driven by firmer domestic demand. Despite geopolitical uncertainty (Brexit, protectionism), export-orientated firms in wholesale, transport and industry are expected to change a gear up this year. For now, the economic recovery in the Eurozone and the lower EUR/USD outweigh the risks. In industry, export order books are filling up at the fastest pace in 6 years.

Despite three years of above-average growth rates, the economy is not expected to return to potential already this year. Unemployment is falling rapidly, but there is still slack in the labour market. The labour force participation rate is lower than at the start of the crisis and this is not caused by ageing. The decline is fully attributable to lower participation amongst the 25 to 45 years old (both men and women). Lacklustre wage growth is another indicator that the economy has further room to grow. Although sectors such as transport, IT, hospitality and temp agencies report more difficulty in attracting new personnel, collective wage agreements in the private sector have resulted in just 1.6%YoY higher contractual wages in 1Q16.

Government finances are looking better and better by the quarter. Last September, official forecasts pointed to a deficit of around 1% for 2016, which was updated to -0.5% in December. Now, actual data show the government already ran a surplus in 2016 of +0.4% of GDP. For 2017-2021, the forecasts for the budget have been revised up by a cumulative 30 billion euro (compared to the September 2016 outlook).

Fig 20 Dutch economy in a nutshell (%YoY)

2015 2016F 2017F 2018F

GDP* 2.0 2.2 2.2 1.8 Private consumption* 1.8 1.7 2.3 1.9 Investment* 9.9 4.8 3.0 2.6 Government consumption* 0.2 1.0 1.0 1.3 Net trade contribution* 0.0 0.2 0.3 0.1

Headline CPI (HICP) 0.2 0.1 1.4 1.3

Unemployment rate (harmonised) 6.9 6.0 4.9 4.4 Budget balance as % of GDP -2.1 0.4 0.7 0.9 Government debt as % of GDP 65.2 62.3 59.8 58.6

Source: Macrobond, all forecasts ING estimates. * Not working day-adjusted

The improved fiscal environment provides a pleasant backdrop for the coalition talks. There is room for several billion euros of extra spending. The finish line is all but impossible to see and the coalition talks could still break down, but a major change in the tax system is likely to be a priority for any new government. Next to lower taxes (mainly for the working-middle class), one should not be surprised to see pension reforms and measures to close the gap between flex/fixed labour in the coalition agreement.

In order to implement new policy in 2018, the coalition agreement needs to be cut and dried well before Budget Day (third Tuesday of September). The current state of the economy gives little reason to rush the process though: a budgetary impulse in 2018 may even prove ill-timed, given the already strong growth pace. If the September deadline is missed, households might only start to benefit in 2019. Incidentally, that might end up being perfect timing. Given the current time schedule, the UK is expected to break away from the EU in 1Q19. The Netherlands is one of the Eurozone countries facing the strongest economic headwinds in the event of a Brexit. Foreign headwinds and domestic tailwinds could cancel each other out, making it possible for the economy to maintain momentum for longer.

Dimitry Fleming, Amsterdam +31 20 57 60 465

…but economy is still not expected to return to potential this year

GDP growth also benefits from stronger exports…

Government finances look better by the quarter…

…providing a pleasant backdrop for the coalition talks


16

Belgium

Cautiously improving

Mixed sentiment indicators and continued political risks in Europe remain a burden for the slow recovery.

Despite slow growth in the fourth quarter, the Belgian economy continued its recovery in 2016. As over the two previous years, it was supported by domestic demand, and more particularly by investments (+2.1% in 2016). To be sure, the evolution of private consumption was rather disappointing, as it increased only by 0.9% in 2016, which is quite low compared to historical levels. The slow growth of the disposable income in the first half of the year and a high inflation (see below) can probably explain this evolution.

International trade also remained a driver for economic activity in 2016. Both exports and imports increased by almost 5.0% last year, as the recovery in the Eurozone had a positive impact on Belgian activity. Moreover, international trade statistics show that (the nominal value of) exports to Japan surged last year. There was also a strong recovery of exports to the BRIC countries.

From an economic point of view, the most significant trend in 2016 was certainly the evolution of employment. Total employment increased by not less than 68,500 jobs between December 2015 and December 2016. This is exceptionally high considering the moderate economic growth. All sectors of the economy (and particularly the private sector) contributed positively to the jobs creation. As a consequence, the number of jobseekers decreased by 4.7% over the period.

Fig 21 Economic growth was supported in 2016 by both domestic demand and external trade

Fig 22 Leading indicators of the labour market show a further decrease of unemployment, but at a slower pace

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The positive evolution on the labour market is likely to be the key driver of the further recovery of the Belgian economy in the coming quarters. Indeed, even if nominal wage growth remains weak, the growth of total employment explains partly why households’ disposable income started to improve in the second half of 2016. We expect a further improvement this year, as the Belgian economy is likely to create around 10,000 additional jobs each quarter.

The Belgian economy continued its recovery in 2016… …mainly thanks to the domestic demand

…and could be the key driver for growth this year…

The labour market improvement was significant in 2016…

But international trade also recovered


17

Moreover, as the capacity utilisation rate of industrial firms is still above 80%, we expect corporate investment to continue to support economic growth in a context of growing exports. All in all, after a 1.2% GDP growth last year, activity is likely to increase by 1.5% this year, and by 1.7% in 2018.

To be sure, these forecasts are quite conservative, as they take some headwinds into account: we continue to fear some negative impact of the Brexit negotiations on the investment activity of corporates. Moreover, other political uncertainties are likely to trouble the current high confidence level. The slight degradation of business confidence in Belgium over the last two months could be the very first sign of these headwinds. Leading indicators of the labour market also indicate a stabilization of unemployment rather than a further decline.

On top of this, one has to take the high inflation and its consequence into account. Even if inflation slowed down in March after having reached 3.0% in February, it remains much higher than the Eurozone average. Transport and housing are mainly responsible for the high inflation. But this is due to the base effect of oil price that hit all economies. However, growing prices of food, hotels, restaurants, tobacco or even communications explain the difference with the Eurozone average.

The higher inflation accelerates the wage indexation process that is likely to deteriorate the competitiveness of Belgian firms. To counter this, constraining the wage indexation (as it was the case in 2015-2016, but not discussed yet) would erase any improvement in disposable income. In all cases, this too high inflation, probably induced by both a lack of competition is some sectors and the wage indexation process itself, is likely to affect the Belgian economy. In this context, our sentiment on the pace of GDP growth remains mixed. At least, it is unlikely to accelerate strongly in the short term.

Belgian public finances are still in consolidation mode. In a context marked by a modest and gradual recovery, reducing the budget deficit of general government and the debt ratio remains anything but easy. The general government deficit remained close to 3% in 2016 (-2.7% to be precise), but is expected to decrease to 2.1% in 2017. So the trajectory of public finances is sound. That said, reaching a budget balance will remain a more difficult challenge: in order to further decrease the budget deficit after 2017 (what is expected in the Stability pact trajectory), an additional substantial fiscal adjustment will have to be done in the years ahead. Moreover, the impact of population ageing on the public finances will increase in the coming years. The government has recently decided to postpone any return to a structural budget balance until 2019. This was anticipated for long in our forecasts, so this announcement doesn’t change anything in our assessment.

Considering the nominal growth of GDP and the public deficit trajectory, the gross debt ratio stabilised in 2016 at 105.6% of GDP. It is likely to decrease slightly this year (104.7%) and in the coming years.

Fig 23 Belgian economy in a nutshell (%YoY)

2015 2016 2017F 2018F

GDP 1.5 1.2 1.5 1.7

Private consumption 1.1 0.7 1.3 1.3 Investment 2.4 2.1 2.1 1.8 Government consumption 1.9 2.7 2.9 2.0 Net trade contribution 0.0 0.8 0.3 0.5

Headline CPI (%) 0.6 2.0 2.0 1.7



Philippe Ledent, Brussels +32 2 547 31 61

…but this was anticipated for long

Keeping public finances on track remains a challenge. The government decided to postpone the return to equilibrium…

…in addition to corporate investment…

…and exports That said, there are clear headwinds…

…focused on the political uncertainty in Europe…

…and on the impact of the higher-than-average inflation


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Other Eurozone countries Fig 24 Confidence needs some re-fuelling to push GDP

Greece: Review completion key to GDP growth…

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The recursive postponement of the completion of the second review of the third Greek programme is proving detrimental to Greek economic growth. A poor 4Q16 GDP reading cast doubts to the attainability of GDP targets as set in the third programme, and rang an alarm bell about the risk of over-complacency over a delayed wrap-up of the review. This likely added some sense of urgency to the parties involved in negotiations, who decided to prioritise big items (labour, pension and fiscal reforms) over smaller ones. An agreement in principle on the sequence of actions required to complete the review was reportedly reached in the last Eurogroup held in Malta early in April. This should involve the parliamentary approval by the Greek of additional labour market, pension, and tax reforms to be progressively implemented from September 2018 onwards, ie, after the end of the third programme. In exchange Greece would get a commitment from lenders to concede medium term debt relief (again, after the end of the third


Fig 25 10y GGB yield positioned for inclusion in PSPP

…and to hopes for medium term debt relief

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programme). In addition, the Greek government would be allowed to legislate counterbalancing post-programme measures worth a total 2% of GDP. While progresses in negotiations seem factual, a full green light will come only after the role the IMF will be made clear. A full involvement of the IMF seems yet to be a necessary condition for northern European lenders to agree to the disbursement of the next tranche. This, in turn, will require both the implementation of reforms and a sustainable debt, which seems possible only if medium term debt relief measures (with no haircut whatsoever) will be committed to in some binding form by European lenders. We see decent chances of a comprehensive agreement to be reached at the next Eurogroup meeting due on 22 May. This, in turn, could pave the way to a new DSA by the ECB, and, eventually, to the inclusion of GGBs in the list of purchasable bonds under the PSPP programme.

Source: Thomson Reuters Paolo Pizzoli, Milan +39 02 552 26 2468

Fig 26 Manufacturing and services still in expansion

Ireland: Strong growth performance…

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In 2016, the economy grew with 5.2%, the highest growth rate in the EU and this for the third year in a row. The good growth performance continued until the end of the year, with a QoQ growth rate of 2.5% in 4Q, and this momentum is expected to last in 2017. Note, however, that important revisions to the stock of capital assets in 2015 led to an artificially high annual growth rate of 26.3%. The figures for 2016 are also affected by this. It is therefore important to look at a broader set of figures to gauge economic activity. But overall, we can conclude that the data continue to paint a positive picture of the Irish economy. The PMI indices for both the services and manufacturing sector remain firmly above 50, so both sectors are in expansionary mode. Moreover, the unemployment rate continues to decline and equals 6.4% in March. It is therefore likely to propel disposable income and, ultimately, private consumption further.

Source: Central Statistics Office Ireland


19

Fig 27 Share of exports to UK is declining, but still high

…with risks tilted towards the downside

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Risks to the outlook are mainly characterized by uncertainty about the external environment. The Brexit is forecasted to have an overall negative effect on the Irish economy and Ireland is therefore more likely to favour a soft Brexit. For now, as the UK economy did not yet weaken, the impact has mainly been felt via the depreciation of the pound against the euro. Adverse developments of the UK economy and potential barriers to trade will hurt sectors that are dependent on UK exports. Sectors such as agri-food, clothing and footwear and tourism, could therefore be disproportionally affected. The Irish financial sector, however, might benefit through the reallocation of certain financial activities from London. Another external risk is that the tax plan of the US president Donald Trump could change investment flows. As Ireland is highly dependent on inward foreign direct investment, this could negatively impact the economy. All in all, we expect those risks to have a limited growth impact in 2017.

Source: T Note: EUbig6: Belgium, France, Germany, Italy, the Netherlands and Spain

Steven Trypsteen, Brussels +32 2 547 33 79

Fig 28 Still a consumption based recovery

Portugal: Growth, still imbalanced, consolidates…

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In 2016 the Portuguese did better than expected, expanding by 1.4%. Private consumption, with a 1.5% contribution to YoY growth, was the key driver, public consumption added another 0.2% while net exports and inventories subtracted 0.1% each. This was the logical consequence of the policies adopted by PM Costa since the start of his mandate. The partial removal of austerity on public wages and pensions combined with healthy employment growth, propelling disposable income. Indeed, after showing some signs of fatigue in 2Q16, employment has expanded at an average 1.9% YoY pace over 2H16. The lack of drive of gross fixed capital formation remains a cause of concern, though. To be sure, the ongoing private sector deleveraging has not been conductive to an acceleration of investment, nor has the financial position of the Portuguese banking system, still burdened by a high stock of non-performing loans. A recovery of investment remains an essential factor for a more balanced, sustainable growth pattern to mate-


Fig 29 Budget deficit on a declining trend

…strengthening political grip and public finances

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rialise. Relatively favourable funding conditions and political stability represent a favourable environment for a tentative investment pick-up over 2017. PM Costa, while heading a minority government, has managed to improve his own popularity and that of the PS party, which is now leading opinion polls by a widening margin over PSD (18ppt gap in April polls). Another conductive factor for a consolidation of the economic recovery is the improvement in public accounts. In 2016, the budget deficit fell to 2.1% of GDP, beating official targets. To be sure, part of the over-performance was due to one-off factors; yet, the trend goes in the right direction. The 2016 debt/GDP ratio, while still at a high 130.4% level, will likely resume declining this year. Decent growth perspectives and the improvement in the deficit could allow Portugal to exit the excessive deficit procedure in 2017. Still no good reasons to be over complacent over delivering more growth friendly structural reforms and making additional efforts to strengthen a banking system still vulnerable to high NPLs.


Paolo Pizzoli, Milan +39 02 552 26 2468


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Fig 30 Inflation will hover around the 2%-mark

Austria: Rosy outlook ahead…

With sentiment indicators strengthening, robust private consumption, a brightening international environment and a favourable labour market, the picture for the Austrian economy remains rosy. Although private consumption should fade slightly in view of the persisting price pressure, it still remains one of the strongest growth drivers for the rest of the year. Inflation will approximate the 2%-mark in the years to come. With the ongoing but fading base effects from last year’s low energy prices and continued strength in the tourism sector, it is unlikely that the current price dynamics are easing out soon.

While demand from European countries has expanded, there is less dynamic from the US. Seeing that uncertainties around US politics and Brexit prevail, stimulus from global trade should be limited.


Fig 31 GDP and employment maintain momentum

…with political stability and new reforms being key

Although the political landscape has calmed markedly, there are still tensions within the ruling coalition (Social Democrats + People’s Party). While both parties emphasise their willingness to cooperate, constant teasing is on the agenda. However, the Social Democrats as well as the People’s Party seem to gain a little bit more popularity. After leading the polls for 23 consecutive months, the far-right Freedom Party has been overtaken by the Social Democrats by a narrow margin of 2%-points in a recent poll. Nevertheless, nationalistic and protectionist tendencies persist.

On the economic front, however, domestic politics do not seem to play a role for the time being. All in all, signs point to a robust economic upturn for 2017. For the Austrian economic outlook to remain rosy, political stability and new reforms are an important prerequisite.


Inga Burk, Frankfurt +49 69 27 222 66131

Fig 32 Labor market can still improve

Luxembourg: strong growth

4

4.5

5

5.5

6

6.5

7

7.5

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

Total employment (YoY, lhs)

Unemployment rate (%, rhs)

is

For the fourth year in a row, the Luxembourg GDP growth was above 4% in 2016. This solid economic activity growth supports a dynamic labour market (employment grew by 2.9% in 2016 and is still accelerating). That said, the natural level of unemployment seems higher than before the crisis (it was below 4%), as a structural unemployment has developed. All in all, the economy remains sound, benefiting from a fast growing population (residents and non-residents), and its specialisation in financial services. In this regard, there are some first signs of financial companies expressing their willingness to move to Luxembourg from London. That said, it isn’t sure that many delocalisation will happen and there are other candidates like Paris and Frankfurt. Inflation was 1.7% in March but is expected to decrease gradually in the coming months. That said, the strength of the economy causes an upward pressure on real estate prices that could become a concern in the event of a long drawn out slowdown.

Source: Thomson Reuters Datastream Philippe Ledent, Brussels +32 2 547 3161


21

Eurozone housing markets Fig 33 ING house price growth forecasts

Eurozone

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

2017 2018

In the EZ, the recovery of house prices continued. After a growth rate of 1.5% in 2015, house prices grew with 2.5% in 2016. For 2017 we expect house prices to grow with 2.9%. House prices are supported by interest rates that remain very low and economic activity that is accelerating. Consumer confidence keeps improving and this also supports house prices. Credit growth, however, does not really accelerate in the Eurozone as a whole and may well place a temporary ‘speed limit’ on Eurozone house prices. Furthermore, business confidence in the construction sector also continues to improve, especially in early 2017, and building permits grew at 12.6% YoY in December 2016. Taking all the above into account, our forecasts, therefore, do not yet show a strong acceleration in house price growth for the time being.

Source: ING

Fig 34 Consumer confidence can support prices

Southern Eurozone

-35

-30

-25

-20

-15

-10

-5

0

-6

-4

-2

0

2

4

6

8

Q12006

Q12007

Q12008

Q12009

Q12010

Q12011

Q12012

Q12013

Q12014

Q12015

Q12016

Q12017

House prices %YoY Consumer confidence (Rhs)

In IT, we expect the ongoing moderate recovery of disposable income and the cheap mortgages to further support house purchases. However, the slack in the market should prevent a big short-run showing on prices. In ES, the pace of recovery in real estate was striking in 2016 and should continue to support the construction sector in 2017 and 2018, though at a slower pace in line with slowing economic growth. In PT, credit conditions remain favourable, but lending activity has been hampered by the ongoing private sector deleveraging. In the short run, the real estate market seems strongly supported by the recovery in disposable income. If employment gains will decelerate, as we expect, the real estate market could cool down somewhat. In GR, the NPLs are still weighing on mortgage lending. In February lending for house purchases was still contracting, but in 4Q16 the contraction of house prices decelerated, so a stabilisation could be in sight.

Source: ECB

Fig 35 Confidence in construction sector improves

Core Eurozone and Ireland

-5-4-3-2-10123456

-2%

0%

2%

4%

6%

8%

10%

12%

Loans to households for house purchase (%YoY)

EZ - House Prices (%YoY - Rhs)

In DE, real estate prices are still benefitting from low interest rates, the strong labour market and the international search for yield. Particularly urban areas are showing signs of tension. Even though a reversal of recent developments is not in sight, some slowing of price increases is in the offing. In FR, the real estate market is improving. In NL, the mixture of record high home sales and supply near pre-crisis lows warrants further price increases. However, some moderation towards 2018 seems likely. In BE, prices grew with 3% in 2016, but is expected to abate significantly in 2017 and 2018. In AT, house price growth accelerated massively in 2016 due to the influx of migrants, the favourable interest rate landscape with low financing costs and due to lack of other attractive investment opportunities. In 2017, market dynamics should cool down somewhat. In IR, price pressures are unlikely to moderate due to supply constraints and strong demand.


Steven Trypsteen , Brussels +32 2 547 33 79


22

ING’s economics forecasts Fig 36 ING’s Eurozone economics forecasts

2015 2016F 2017F 2018F 1Q 2Q 3Q 4Q FY 1Q 2Q 3Q 4Q FY 1Q 2Q 3Q 4Q FY 1Q 2Q 3Q 4Q FY

GDP growth (%QoQ, ann) Germany 0.7 2.1 1.0 1.4 1.5 2.8 1.6 0.8 1.9 1.8 1.3 1.6 1.6 1.6 1.5 1.4 1.4 1.6 1.5 1.5 France 2.5 0.1 1.4 0.9 1.2 2.5 -0.6 0.8 1.7 1.1 2.0 1.0 0.8 1.6 1.3 2.4 1.6 1.6 1.6 1.7 Italy 1.1 1.5 0.3 0.9 0.7 1.8 0.4 1.0 0.7 0.9 0.7 1.2 0.7 0.9 0.8 1.0 0.9 1.0 0.8 0.9 Spain 3.9 3.1 3.8 3.4 3.2 3.1 3.4 2.8 2.8 3.2 2.8 2.4 2.6 2.4 2.7 2.4 2.4 2.0 2.0 2.3 Netherlands 2.3 0.4 0.8 1.0 2.0 2.7 3.0 3.4 2.5 2.2 1.4 2.5 2.0 1.6 2.2 1.9 1.4 2.0 2.2 1.8 Belgium 1.6 2.4 0.4 2.0 1.5 0.4 2.0 0.8 2.0 1.2 1.6 1.6 1.2 1.6 1.5 2.0 1.6 1.6 1.6 1.7 Austria 1.1 0.6 1.3 1.3 1.0 2.4 0.4 2.0 1.5 1.5 1.9 1.5 2.0 1.6 1.8 1.8 1.4 1.7 1.5 1.6 Greece 2.5 -0.4 -6.9 7.6 -0.3 -3.0 1.0 2.4 -4.9 -0.1 3.0 2.0 4.8 2.7 1.3 2.0 2.0 2.6 2.6 2.6 Ireland 118.2 4.0 6.6 8.7 26.3 -2.7 3.1 16.9 10.2 5.2 0.8 0.8 1.6 1.6 4.7 2.4 2.4 2.4 2.4 2.1 Portugal 2.4 1.1 0.5 1.4 1.6 1.1 0.9 3.4 2.5 1.4 1.2 0.9 1.4 1.9 1.7 1.2 1.5 1.6 1.5 1.4

Eurozone 3.3 1.6 1.1 2.0 1.9 2.1 1.3 1.7 1.6 1.7 1.9 1.6 1.6 1.8 1.7 1.8 1.7 1.7 1.6 1.7

Headline inflation (%YoY) Germany -0.1 0.4 0.1 0.2 0.1 0.1 0.0 0.4 0.9 0.4 2.0 1.8 1.7 1.3 1.7 1.2 1.7 1.7 1.9 1.7 France -0.2 0.2 0.1 0.1 0.0 0.0 0.0 0.3 0.5 0.2 1.2 1.0 1.5 1.6 1.4 1.6 1.6 1.5 1.5 1.6 Italy -0.1 0.1 0.3 0.2 0.1 0.0 -0.3 -0.1 0.2 -0.1 1.2 1.4 1.3 1.2 1.3 1.0 1.2 1.3 1.4 1.2 Spain -1.1 -0.3 -0.6 -0.5 -0.6 -0.8 -1.0 -0.3 0.8 -0.3 2.7 2.4 1.7 1.6 2.1 1.5 1.6 1.8 1.5 1.6 Netherlands -0.5 0.4 0.5 0.4 0.2 0.4 -0.2 -0.2 0.5 0.1 1.4 1.4 1.3 1.3 1.4 1.3 1.2 1.4 1.5 1.3 Belgium -0.5 0.5 0.8 1.4 0.6 1.8 2.1 2.1 1.9 2.0 2.6 2.0 1.8 1.7 2.0 1.7 1.8 1.8 1.9 1.7 Austria 0.6 1.0 0.9 0.8 0.8 1.0 0.6 0.8 1.5 1.0 2.2 2.0 1.8 1.6 1.9 1.5 1.5 1.8 1.8 1.7 Greece -2.2 -1.4 -0.8 0.1 -1.1 -0.2 -0.1 0.2 0.2 0.0 1.4 1.3 0.9 0.8 1.1 0.7 0.8 1.2 1.3 1.0 Ireland -0.3 0.1 0.1 0.0 0.0 -0.3 -0.1 -0.2 -0.3 -0.2 0.3 0.5 0.7 0.9 0.6 1.0 1.3 1.5 1.7 1.4 Portugal 0.0 0.7 0.8 0.5 0.5 0.4 0.5 0.7 0.8 0.6 1.4 1.4 1.3 1.5 1.4 1.3 1.3 1.5 1.6 1.4

Eurozone -0.3 0.2 0.1 0.2 0.1 0.0 0.0 0.3 0.7 0.3 1.8 1.5 1.4 1.3 1.5 1.2 1.4 1.5 1.6 1.4

Refi minimum bid rate (%, eop) 0.05 0.05 0.05 0.05 0.05 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 3-month interest rate (%, eop) 0.02 -0.01 -0.04 -0.14 -0.22 -0.26 -0.30 -0.31 -0.33 -0.32 -0.32 -0.32 -0.32 -0.32 -0.25 -0.10

EUR/USD (eop) 1.05 1.10 1.12 1.09 1.10 1.11 1.12 1.05 1.02 1.05 1.10 1.12 1.13 1.14 1.15 1.15 USD/JPY (eop) 120 123 120 120 112 103 101 112 118 116 118 120 118 120 120 120

Source: ING estimates, for the entire range of all ING forecasts, please go to INGX <GO>


23

Research analyst contacts Developed Markets Title Telephone Email

London Mark Cliffe Head of Global Markets Research 44 20 7767 6283 [email protected] Rob Carnell Chief International Economist 44 20 7767 6909 [email protected] James Knightley Senior Economist, UK, US, $ Bloc 44 20 7767 6614 [email protected] James Smith Economist, Developed Markets 44 20 7767 1038 [email protected]

Chris Turner Global Head of Strategy and Head of EMEA and LATAM Research

44 20 7767 1610 [email protected]

Petr Krpata Chief EMEA FX and IR Strategist 44 20 7767 6561 [email protected] Viraj Patel Foreign Exchange Strategist 44 20 7767 6405 [email protected]

Padhraic Garvey Global Head of Debt and Rates Strategy 44 20 7767 8057 [email protected] Aengus McMahon Senior Utility Analyst, Head of Corporate Research 44 20 7767 8044 [email protected] Juan Carrion Head of High Yield Research 44 20 7767 8379 [email protected]

Amsterdam Maarten Leen Head of Macro Economics 31 20 563 4406 [email protected] Teunis Brosens Senior Economist, Eurozone 31 20 563 6167 [email protected] Bert Colijn Senior Economist, Eurozone 31 20 563 4926 [email protected] Raoul Leering Head of International Trade Analysis 31 20 563 4407 [email protected] Timme Spakman Economist, International Trade Analysis 31 20 576 4469 [email protected]

Marieke Blom Chief Economist, Netherlands 31 20 576 0465 [email protected] Dimitry Fleming Senior Economist, Netherlands 31 20 576 0465 [email protected]

Jeroen van den Broek Head of DM Strategy and Research 31 20 563 8959 [email protected] Maureen Schuller Head of Covered Bond Strategy and Financials

Research 31 20 563 8941 [email protected]

Martin van Vliet Senior Rates Strategist 31 20 563 8801 [email protected] Benjamin Schroeder Senior Rates Strategist 31 20 563 8955 [email protected] Quentin Gilletta de Saint Joseph Debt Strategist 31 20 563 8957 [email protected] Hamza Khan Head of Commodities Strategy 31 20 563 8958 [email protected] Warren Patterson Commodities Strategist 31 20 563 8921 [email protected] Mark Harmer Senior Credit Analyst, Financials 31 20 563 8964 [email protected] Suvi Platerink Kosonen Senior Credit Analyst, Banks 31 20 563 8029 [email protected] Hendrik Wiersma Senior Credit Analyst, TMT 31 20 563 8961 [email protected] Job Veenendaal Credit Analyst, Consumer Products and Retail 31 20 563 8956 [email protected] Roelof-Jan van den Akker Head of Technical Analysis 31 20 563 8178 [email protected]

Brussels Peter Vanden Houte Chief Economist, Belgium, Eurozone 32 2 547 8009 [email protected] Julien Manceaux Senior Economist, France, Belgium, Switzerland 32 2 547 3350 [email protected] Philippe Ledent Senior Economist, Belgium, Luxembourg 32 2 547 3161 [email protected] Steven Trypsteen Economist, Ireland, Portugal 32 2 547 3379 [email protected] Geoffrey Minne Economist, Spain 32 2 547 3386 [email protected]

Frankfurt Carsten Brzeski Chief Economist, Germany, Austria 49 69 27 222 64455 [email protected] Inga Burk Economist, Germany, Austria 49 69 27 222 66131 [email protected]

Milan Paolo Pizzoli Senior Economist, EMU, Italy, Greece 39 02 55226 2468 [email protected]

Emerging Markets Title Telephone Email

New York Gustavo Rangel Chief Economist, LATAM 1 646 424 6464 [email protected]

London Dorothée Gasser-Châteauvieux Chief Economist, EMEA 44 20 7767 6023 [email protected] Nicholas Smallwood Senior Emerging Markets Credit Analyst 44 20 7767 1045 [email protected]

Czech Rep Jakub Seidler Chief Economist, Czech Republic 420 257 47 4432 [email protected]

Hungary Péter Virovácz Senior Economist, Hungary 36 1 235 8757 [email protected]

Philippines Joey Cuyegkeng Senior Economist, Philippines 632 479 8855 [email protected]

Poland Rafal Benecki Chief Economist, Poland 48 22 820 4696 [email protected] Piotr Poplawski Senior Economist, Poland 48 22 820 4078 [email protected] Jakub Rybacki Economist, Poland 48 22 820 4608 [email protected] Karol Pogorzelski Economist, Poland 48 22 820 4891 [email protected]

Romania Ciprian Dascalu Chief Economist, Romania 40 31 406 8990 [email protected] Silviu Pop Junior Economist, Romania 40 31 406 8991 [email protected]

Russia Dmitry Polevoy Chief Economist, Russia and CIS 7 495 771 7994 [email protected] Egor Fedorov Senior Credit Analyst, Russia and CIS 7 495 755 5480 [email protected]

Singapore Tim Condon Head of Research & Chief Economist, Asia 65 6232 6020 [email protected] Prakash Sakpal Economist, Asia 65 6232 6181 [email protected]

Turkey Muhammet Mercan Chief Economist, Turkey 90 212 329 0751 [email protected]

mailto:[email protected]


24

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