Outlook for Spain: Recession

The well-deserved euphoria over the European Championship in football has brought welcome relief to Spanish consumers, weighed down by a slow economy. However, global economies have not decoupled from the U.S. slowdown. European economies are suffering, Denmark having already declared recession.

In this piece I am going to take a look at the Spanish economy and make a prediction as to where it is headed.

I want to look at several factors in Spain’s economic outlook: housing, employment, inflation, interest rates, retail sales, production, and income.

Housing

Demand for housing in Spain is way down with the number of transactions collapsing, thus denting the municipal tax base in an economy where property transaction taxes had become a major source of income. Homes sales of 157,539 units were recorded in Q1 2008, representing a whopping decrease of 31.8% compared with the same period of 2007, according to data distributed by the Spanish Ministry of Housing. Existing home sales have suffered the most in the Spanish housing crash, with sales down 46.9% year-on-year. New home sales in Q1 2008 were still down 12.9% from the same period a year ago when 89,543 units were sold.

As yet, I have no data on prices, but all indications are that prices are down considerably from last year. Mortgage defaults are expected to hit 2% by year’s end, the highest rate in the eurozone, according to forecasts by the Spanish Mortgage Association (AHE). The AHE expects default rates to continue to grow in 2009.

Employment

The housing crash has had negative effects on employment. Unemployment in June rose to 2.39 million in Spain, an increase of 1.5% over the previous month. Since June 2007, unemployment in Spain has increased by 424,555 people, taking unemployment from under 2 million to its present levels.

As would be expected because of Spain’s housing bust, the construction sector has been hardest hit, having registered 21,080 new unemployed in June 2008. Now, immigrants in Spain have an unemployment rate of 23.8%. This is worrying as xenophobia and anti-immigrant feelings are on the rise in the country.

Unfortunately, this trend should continue unabated as the OECD expects Spain to have the highest unemployment rate of OECD countries in 2009 at 10.7%. This will be the major drag on consumption going forward and all but assures a recession in Spain.

Inflation

Meanwhile, prices in Spain are rising because of higher energy and food costs, just as they are across the globe. In the eurozone as a whole the annual consumer price inflation rate was 4% for June 2008, double the ECB’s target rate. That’s the highest since 1996 according to Eurostat. In Spain itself, inflation rose to 4.7% in June, according to the Spanish National Statistics Institute (INE).

At the wholesale level prices are now rising incredibly fast. According to the Spanish National Statistics Institute (INE), theIndustrial Prices Index recorded an increase of 1.2% in May compared to April and was up 7.9% over the same month last year, boosted in particular by food and energy prices. These rises have not been passed on to consumers yet because of slack consumer demand.

Obviously, inflation was a major factor in the strikes in Spain last month and continues to weigh on consumer sentiment and demand.

Interest Rates

With inflation increasing around the globe and inflation in the Eurozone already uncomfortably high, the ECB will look to raise rates. The ECB has a single mandate toward inflation; therefore they have no other policy options.

Interest rates, therefore, will not help the Spanish consumer as Euribor continues to increase. As of yesterday, Euribor had risen to 5.361%, 0.856% more than a year ago when rates were 4.505%. That’s costing the average mortgage holder in Spain another 84 Euros per month (more than 1,000 euros per year). With less money to spend because of interest rates and inflation that is going to have to take a bite out of consumer demand.

Retail sales

Consumer sentiment in Spain is being negatively impacted by the housing downturn and the employment situation, not to mention interest rates and inflation. The 2008 Eurobarometer counts the Spanish as the most pessimistic of all of the European Union.

Retail sales are suffering as a result. A recent article in ABC pointed out that the Spanish spent 15% less in the May and June sales season than they did last year.

Auto sales, in particular have plummeted, falling 17.3% in the first six months of 2008 compared with the year ago period. This is the worst fall since 1993.

Overall, consumer trends in Spain are negative.

Production

Manufacturing activity has taken it on the chin in Spain, a big producer of automobiles. The Spanish purchasing managers index sank to its lowest level since records began in 1998, falling to 40.6 in June from 43.8 in May. 50 indicates recessionary levels. In June, the General Industrial Production Index (IPI) reported that production fell for the second month running, yet another sign that manufacturing is very weak in Spain.

Clearly, the manufacturing sector in Spain is in recession.

Income

Salaries have increased 5.1% over 2007 including overtime and arrears. Base salaries in Spain increased 5% year-on-year. But, to keep up with inflation and rises in interest rates, the Spanish worker will need to see annual increases in excess of 5% going forward as well. Will these increases last? It is hard to say. But, for now, salaries are just keeping pace with inflation.

Conclusion

Looking at the data on the Spanish economy was brutal. The data point to a softening worse than in the U.S. or in the UK. Clearly, the Spanish economy will be in recession soon, if it is not already. Given the predictions regarding interest rates and the housing and construction sectors in particular, one can only assume that this will be a long and deep recession for Spain and I don’t expect a pickup until the second half of 2009 at the earliest.