Royal Bank of Scotland : Economics Weekly - A spectre haunting Europe

Just a month ago the IMF put the probability of recession in the Eurozone at nearly 40% over the coming year. Last week Europe took one small step away from that precipice. The single currency area grew by 0.2% in Q3. Hardly blistering, but better than expected. Particularly pleasing were improved performances from the giants of Germany and France. France managed 0.3% growth, its best result for over a year. Whilst Germany reversed Q2's minor fall in output to post the smallest increase (0.1%). Elsewhere Spain maintained its good growth momentum, with output now 1.6% higher than a year ago. But Italy shrank yet again, meaning its economy is now almost 10% smaller than before the crisis. Much work remains.

Inflation in the Eurozone inched up to 0.4% in October but remains perilously close to negative territory. Price growth has averaged less than 1% for an entire year now. And that's in spite of the ECB's repeated efforts to get growth going through rate cuts, asset purchases and discounted loans. Falling oil prices, now down 30% since the summer, will add further downward pressure on inflation over the coming months. The absence of meaningful inflation in Italy in particular makes dealing with its public debt burden even harder.

Since the Bank of England's August inflation report markets have pushed out their expectation of when interest rates will rise from the first quarter of 2015 to the last. The MPC's analysis of the UK economy did nothing to dispel that shift. It expects inflation to be lower for longer, only reaching its 2% target in three years time and possibly falling below 1% in the meantime as falling energy and food prices take effect. Sluggish price growth should help consumers' purchasing power but wage growth is expected to be too low to support higher spending. Instead the MPC thinks Britain's households will save less to sustain the pace of growth. They've done that before, but this makes the UK's growth outlook vulnerable to a knock in confidence. And with the growth outlook in Europe so bleak, it's not hard to imagine where that might come from.

Both the unemployment and employment rates stayed where they were in the three months to September, at 6% and 73%, respectively. All of the gains in employment were among employees, as Q3 saw a reduction in the number of self-employed compared with the previous three months. Total hours worked fell by 0.3%q/q. Given that the economy expanded by an estimated 0.7%q/q, UK productivity experienced some all too rare growth. With the youth unemployment rate down to 16.2%, long-term unemployment falling by 53k people and a reduction in the numbers of part-time workers looking for a full-time job, Q3 brought plenty of good news.

On a like for like basis, the headline rate of pay growth (excluding bonuses) was almost the same as inflation in the third quarter of the year. A bit more growth would finally end a situation that has persisted almost uninterrupted since July 2008. And with falls in the price of oil likely to bear down further on consumer price inflation, there is every reason to be hopeful. Private sector pay grew by 1.6%y/y, already above increases in the cost of living. Manufacturing pay growth was out in front at 1.8%y/y, while wholesale and retail sector pay growth only managed 0.6%y/y growth. Is the UK labour market finally starting to run out of spare capacity?

For the third month in a row house price expectations in the capital have weakened. Just as striking is that more surveyors are reporting that prices are already falling than are reporting that they are rising. Is this the last call for the latest London housing party? If it is, it does not bode well for the rest of the UK, where price growth is expected to weaken over the next six months. While expectations for London are more pessimistic (which is unusual for the RICS survey) there is no question that in the UK, the animal spirits that drive house prices tend to move together. We await future surveys to see just how weak these expectations will get.

UK construction grew by 2.9% in Q3 compared with a year ago, led by house building. Both public and private housing construction grew rapidly, at 35%y/y and 22%y/y, respectively. But it was another disappointing 12 months for infrastructure, which saw building decrease by 5.5%y/y. The importance of housing to our fixed capital stock should not be underestimated. It accounted for 41% of the total in 2013, while commercial and industrial buildings made up 36%. The remainder was split between machinery and equipment, intellectual property products and other commercial equipment.