In Q4 2010, Spanish GDP edged up 0.2% on the back of relatively strong net trade. For the year as a whole, activity contracted 0.1%. We expect a very sluggish recovery this year, with GDP growth of just 0.7%. Domestic demand will continue to hold down growth. We expect household consumption to increase just 0.5% in 2011, reflecting the impact of the depressed labour market on household income. Meanwhile investment will contract (by 2.2%) for the fourth consecutive year. While non-residential capital formation will remain basically flat, the sharp fall in construction will continue and we expect residential investment to shrink by a further 12.2% this year. The ongoing fragility of the banking sector remains by far the largest downside risk for the economy. While banks regained access to market financing in Q4 last year, as seen by a fall in ECB loans, they remain reluctant to provide credit. Plans to restructure regional savings banks have come into force, but analysts antiestéticar that the cost to public finances may exceed the officially estimated 20bn. The need to support the banking system is a major risk to the deficit consolidation process, which is otherwise proceeding smoothly. The budget deficit may shrink to 6.3% of GDP this year, close to the governments 6% target, but spreads over German bunds remain wide.
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