Euro zone periphery on recovery track but deflation a worry: Reuters poll

Thu Jul 17, 2014 10:28am EDT

(Reuters) - Some of the euro zone's most vulnerable economies are set for stable if lackluster growth over the coming year and deflation remains a serious threat, a Reuters poll of economists showed on Thursday.

The economic outlooks for Ireland and Spain were seen as slightly more positive than in the last poll three months ago, while the projection for Greece was unchanged. The outlook for Portugal was slightly downgraded.

Little or no improvement was seen in employment prospects for the periphery's citizens, who still face extremely high rates of joblessness.

The poll provides no relief either for the European Central Bank, which cut its deposit rate to below zero in June and announced more cheap loans to banks in a bid to push inflation, running at 0.5 percent, back towards its target near 2 percent.

"There is improvement in these countries but that doesn't mean the crisis is over. They have to manage big imbalances like external debt, public debt and unemployment," said Jesus Castillo, economist at Natixis in Paris.

"Inflation, like in the (wider) euro zone, will remain very low for several months ... and unemployment is a big, big issue in Spain and Greece especially and there are no signs of quick improvement."

Ireland, the first economy to exit its EU/IMF bailout program and return to financial markets six months ago, is expected to lead recovery in the periphery this year, growing 1.8 percent, better than the euro zone as a whole.

"For now at least, Ireland is continuing to provide hope for the peripheral economies that there is life after a bailout," wrote Jonathan Loynes, Chief European Economist at Capital Economics, in a note.

But Ireland makes up a tiny fraction of the euro zone economy. A return to capital markets by Greece and Portugal has also spurred some optimism for marginal growth in these countries, but not much.

Greece is expected to grow 0.3 percent this year and 1.7 percent in 2015, the same as three months ago. Portugal's economy is seen growing 1.0 percent this year, slightly less than in April's poll, and an unchanged 1.5 percent next year.

More importantly, there has been no change to concerns that weak output in these countries may spread further into the wider currency bloc, which is struggling with very low inflation.

Greece, which has gone through an economic depression, is already deflating, and prices are now falling on an annual basis in Portugal. Even Spain, the euro zone's fourth largest economy after Italy, reported almost no inflation in June.

"Spain is not immune from the risk of deflation, but this risk should be reduced as growth picks up," wrote Paolo Mameli, euro area economist at Intesa Sanpaolo.

"In any event, Spanish inflation will struggle to rise substantially above 0.6–0.8 percent in 2015."

Portugal, which has a similar economic outlook to Spain, faced intense scrutiny from financial markets this month after the holding company of Banco Espirito Santo, the country's largest listed bank, was forced to sell a 4.99 percent stake to repay a margin loan after reporting a financial irregularity.

Yields on Portuguese sovereign debt leapt and the bank's shares traded at record lows as market participants shunned these assets. But there has been no material impact on the outlook for Portugal.

Forecasts for budget deficits in the poll, taken in the past week, are almost unchanged from three months ago.

Economists expect Portugal and Ireland to meet their budget deficit targets of 4 percent and 4.8 percent but expect Spain and Greece to miss their targets by a small margin.

Debt to GDP ratios for these economies have increased since the euro zone crisis began in 2010, despite punishing austerity measures over those years.

Greece, Ireland and Portugal figure among the countries with the highest debt to GDP ratios in the euro area. Greece tops the list with more than 175 percent debt to its GDP.

In addition to fiscal austerity, a strong euro, trading at $1.353, has held back these economies as it has made their exports less competitive. The latest Reuters poll data shows the euro will weaken slightly but still trade around $1.33 for the remainder of the year.

"If you don't get the currency down, it increases the threat of deflation," said Alan McQuaid, chief economist at Merrion Capital in Dublin.

(Additional reporting by George Georgiopoulos in Athens; Polling and analysis by Sarbani Haldar; Editing by Catherine Evans)

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