Significance: According to the National Statistical Office, Spanish real GDP was unchanged between the second and third quarters of 2010.

Implications: The quarter-on-quarter breakdown of third-quarter GDP was very disappointing, revealing that only a very steep drop in imports prevented a renewed contraction in real GDP between the second and third quarters.

Outlook: Spain may avoid a technical recession in the coming months, but by any other definition the economy is engulfed by recessionary conditions—falling employment, low core inflation, a prolonged real estate slump and still rising unemployment when compared to a year ago. Our outlook remains gloomy, with real GDP expected to contract by 0.3% in 2010 before expanding modestly by 0.3% in 2011 and 1.1% in 2012, according to the November interim forecast.

According to the final release from the National Statistics Office, Spain avoided contraction in the third quarter of 2010. Real GDP is estimated to have been flat between the second and third quarters, after rises of an upwardly revised 0.3% quarter-on-quarter (q/q) in the second quarter and 0.1% q/q in the first. Spain emerged from its technical recession in early 2010, after ending a sequence of six consecutive quarters of declines. In annual terms, real GDP grew by just 0.2% year-on-year (y/y) in the third quarter, compared to being flat in the second quarter and 1.4% y/y drop in the first. 

The q/q breakdown of third-quarter GDP was very disappointing, revealing that only a very steep drop in imports prevented a renewed contraction in real GDP between the second and third quarters. The key expenditure sectors of consumer spending and business and construction investment declined notably in the third quarter, while the export revival lost considerable momentum.

Consumer Spending Falls Back Notably

Private consumption (excluding non-profit institutions) retreated sharply in the third quarter of 2010, resulting from the end of the one-off boost to spending on services during Spain's successful World Cup campaign in the second quarter, coupled with the drag arising from the VAT increase on 1 July and the end of the car scrappage scheme at the end of June. Consequently, overall household spending contracted by 1.1% q/q in the third quarter, after a 1.5% q/q rise in the previous quarter. In annual terms, it was up 1.4% y/y in the third quarter, down from a 2.2% y/y gain in the March-June period, the first increase since mid-2008. A breakdown by type of good and service reveals notably weaker new car sales, with new registrations dropping 25.0% y/y in the third quarter after a 39.5% y/y increase in the half of 2010. Clearly, car sales have been hit after the withdrawal of the car scrappage scheme, which gave buyers who scrapped an old car and bought a new, environmentally friendly one an incentive of 2,000 euro. In addition, spending on other goods and services was weak. There is some evidence that consumers brought forward purchases to avoid the VAT rise on 1 July 2010. Spending on services was particularly weak in the third quarter, highlighted by a marked deterioration in the survey results from the sector.

Investment Activity Shrinks Alarmingly

Fixed investment spending continued to spiral down and at an accelerated pace in the third quarter of 2010, falling 3.0% q/q after a 0.6% q/q drop in the second quarter. This was the 12th successive q/q decline in fixed investment, causing it to fall by 7.0% y/y in the third quarter and 6.8% y/y in the second quarter. Ongoing concerns about the health of the property market continued to diminish construction activity, which contracted by 3.2% over the third quarter and was 11.6% lower than a year ago. This was 11th consecutive quarter to register a decline on both quarterly and annual basis. Residential investment continued to slide as the sector is still weighed down by a large stock of unsold properties and markedly weaker than normal demand for housing. The impetus from other construction activity, including public investment, appeared to lose some momentum due to the winding up of infrastructure projects funded by the State Local Investment Fund. Spending on equipment slumped by 5.2% q/q in the third quarter, slowing the y/y change to +2.4% y/y from +8.7% in the second quarter, the first annual increase since mid-2008. Clearly, still weak industrial production and still low capacity utilisation continue to mute certain types of business investment.

Government Spending Retreats Signalling Start of Austerity Drive

An additional drag on domestic demand in the third quarter of 2010 arose from government spending, which fell back 0.4% q/q in the third quarter, following rises of 0.7% q/q in the second quarter and 0.1% q/q in the first. In annual terms, it edged down by 0.1% y/y in the third quarter, the first fall recorded since the quarterly series began in 1995. The government has wound up its fiscal stimulus measures after spending heavily to prop up the economy. The official Plan E 2009 had been set to fill the void left by the residential construction slump, with central and local governments spending 8 billion euro on some 30,000 infrastructure projects all over Spain during 2009.

Spanish Export Revival Loses Momentum

Exports of goods and services slowed notably in the third quarter, rising by just 0.1% q/q, after rises of 1.4% q/q in the second quarter and 4.1% q/q in the first. Nevertheless, exports were still up by 8.7% y/y, the third consecutive annual rise, but they have lost some ground after an11.6% y/y gain in the second quarter. The benefits of the weaker euro in May and June are fading, but Spanish exporters continue to exploit the gradual recovery in demand across the Eurozone, United Kingdom and United States. Meanwhile, import demand weakened markedly in the third quarter, falling 5.3% q/q but remained 3.9% higher than a year ago.

Outlook and Implications

The q/q breakdown of third-quarter GDP was very disappointing, and signals that the economy is clearly struggling. In addition, the situation appears to be worse than the Bank of Spain's assertion last week that overall economic activity stagnated temporarily in the third quarter, and is set to return to a "mild recovery track". Worryingly, several indicators deteriorated at the start of the fourth quarter, primarily a renewed fall in consumer confidence, a brisker contraction in service sector activity and tumbling new car sales, suggesting the economy is failing to generate any recovery momentum.  

Spain may avoid a technical recession in early 2011, but by any other measure the economy remains mired in recession, signalled by very weak domestic spending, struggling labour market and a prolonged real estate slump. Specifically, domestic spending contracted at a brisker pace in the third quarter, and the outlook is far from encouraging. Consumers remain very downbeat, struggling to adapt the rise in VAT, higher energy and housing costs, the renewed rise in unemployment and the end of the car scrappage scheme.  Meanwhile, the investment climate remains tough, with Spanish companies continuing to endure below normal capacity utilisation, uncertain profitability, and recovering—but still very fragile—demand both at home and abroad. This is compounded by the continuous weakness of residential construction, with the property market struggling to absorb a million-plus unsold new properties. Furthermore, the economy has yet to face the full impact of the tough austerity measures, which will be a severe jolt after the prolonged period of deep government fiscal stimulus. The positive contribution from the external sector is likely to wane over the coming months. Worryingly, the export environment is likely to be increasingly challenging in late 2010 and 2011, weighed down by the prospect of weaker global recovery, uneven domestic demand in several European countries with governments implementing tough austerity measures and significant euro gains after plunging to its early June 2010 low of 1 euro:US$1.19. Spanish exporters could struggle to sustain their impressive performance witnessed during 2010. 

We expect real GDP to contract by 0.3% in 2010 before expanding modestly by 0.3% in 2011 and 1.1% in 2012, according to our latest forecast.