Economic Outlook Europe: Long-term prospects

After three years of declines, European construction markets held their own in 2011, but spending levels have contracted once again in 2012 as the recession resumes, and 2013 does not hold much promise. Growth will return in 2014, but it will be at least 2019 before construction spending regains its 2008 level.

IHS Global Insight estimates that the Eurozone economy contracted -0.3% quarter-on-quarter this spring and is headed for a steeper decline in the third quarter.

Persistent sovereign debt, banking, and competitiveness problems in Greece, Spain, and to a lesser extent, Italy are undermining confidence and adding to uncertainty about the economic outlook. Even in relatively buoyant Germany, current data suggests that strength in domestic consumer markets is increasingly overshadowed by weakness in export markets.

A Greek exit from the Euro is widely anticipated, and as this outcome becomes ever more probable in the coming months, policymakers will take significant steps toward full financial and fiscal union to safeguard the remaining members. This will limit (but not fully prevent) financial market instability and collateral damage from the Greek exit.

Even so, financial pressures on Spain have intensified as government bond yields rose above the challenging 7% mark, despite a new fiscal austerity package. While we expect that Spain will meet its funding needs over the remainder of 2012, its financial situation will become more precarious in 2013 as its recession continues.

It is possible that Spain will need a sovereign debt bailout by the end of 2013, although there is growing expectation the European Central Bank (ECB) will do whatever is necessary to prevent Spain and Italy from suffering the same fate as Greece. Despite that, Eurozone real GDP is projected to decrease -0.5% in 2012 and -0.3% in 2013, before rising +0.7% in 2014 and +1.7% in 2015.

Given the economic climate, the outlook for Western Europe construction remains poor. Total construction spending will increase at an anaemic +0.9% a year from 2011 to 2016. The non-residential structures segment will enjoy the 'strongest' outlook with average annual increases of +1.2%, and residential construction spending will grow at a +1.0% a year.

Austerity budgets in several countries will work to reduce government spending, which is the largest source of infrastructure funding - leading to reductions in this component of construction. As such infrastructure spending in the region will only expand at an average annual rate of +0.4%, but this masks declines over the first part of the forecast.

Germany, Scandinavia, particularly Norway, and Turkey lead growth over the forecast. Germany has benefited from a strong industrial base that has been supplying emerging markets with the tailwind of a weak Euro. As emerging markets slow, so too will Germany's economy, although its strong fiscal position allows it to still outperform most of the continent.

Scandinavia managed to avoid most of the excesses that have struck other countries and has been able to avoid overly restrictive policies moving forward. Turkey has benefitted from reforms put in place after a financial crisis in 2001, but has also positioned itself as a key industrial supplier to the Middle East, where strong oil prices have provided solid opportunities.

Residential construction

Residential construction is the largest component of Western European construction and has contracted for three of the past four years, with double digit declines in 2009. We expect virtually no growth over the next two years, with only modest growth returning in 2014. Western Europe's residential spending is not expected to reach the pre-recession levels of 2007 in real terms before 2021.

The UK has the strongest residential outlook over the forecast with +4.1% compound growth over 2011-16, while Germany and France will struggle to see even half that rate of growth. For the troubled economies of Greece, Portugal and Spain, residential construction will be lower in 2016 than it is today.

Spending on non-residential structures will contract slightly in 2012, before edging upward in 2013 and beyond. While no segment is particularly strong, office construction growth will be strongest in the recovery as the financial sector comes back. Institutional structures will offer opportunity later in the forecast as fiscal balances are restored and deferred public sector investments resume.

Spending growth will be strongest in the manufacturing-intensive economies of Scandinavia, Germany and Turkey. As with the residential sector, Spain, Portugal and Greece will continue to see non-residential contraction over much of the forecast, and Ireland will also struggle. The weakest element will be commercial construction as retail spending lags given a prolonged period of weak consumer confidence.

It is the infrastructure segment that has been the largest victim of the downturn given the prescription of austerity for many economies. As the chart on p. 16 indicates, over the next five years, infrastructure spending in Europe as a whole will finally offer some gains, but they will be meagre.

Among the major economies, the largest problems come from Spain, down -4.1% annually over the next five years on average. Germany will fare the best among major countries as its economy soars by European standards, yet problems for the wider Euro zone will pre-empt large scale public investments in Germany.

The UK appears poised to weather the post-Olympic transition. Growth will slow, but given the scale of infrastructure investments made for the Games, maintaining growth while weaning off the stimulus is a real accomplishment and much better than anticipated just a year ago.

Turkey leads all comers with spending growth in excess of the global average, but Turkey more closely resembles an emerging market than a European country when considering infrastructure investment.

Uncertainty

While the region continues to struggle with a true resolution for its fiscal and financial difficulties, uncertainty will remain high. Such an environment is not conducive to new investment, and the effect is compounded by weak conditions elsewhere in the world.

Combined with austerity, excess capacity, and tight credit conditions, it is difficult to see anything but a stagnant near term for Europe's construction outlook, followed by an anaemic recovery in the medium to long term.