The economy slows and inflation declines
After having collapsed at the start of the Covid crisis in Q2 2020, the Portuguese economy grew rapidly from Q1 2021 onwards as the country reopened. Naturally, growth rates fell during 2022 from 11.9% year-on-year in Q1 to 3.2% year-on-year in Q4. Overall, real GDP growth in 2022 was 6.7%.
An important driver of economic growth has been the tourism sector. In 2022 tourism recovered to the level of 2019. However, before Covid tourism grew by roughly ten percent per year, implying that the 2022 level was much below trend. In January 2023, the number of nights spent in tourist accommodation was about 15% higher than in January 2019, suggesting that tourism growth has returned.
As in most other countries, inflation remained low in 2020 despite Covid, but rose in 2021 and surged in 2022. Most recently, it has declined but headline and core inflation are both high, indicating that inflation is broad based and not solely due to rising energy and food prices. Given its sluggishness, it will take some time before inflation has returned to levels generally associated with price stability.
Lending slows as rates rise
The slowing of the economy is also apparent from loan growth. As in many other countries, loans to non-financial corporations grew very rapidly following the start of the Covid crisis as firms sought to bridge what they expected to be a temporary period of very low or zero cash flow. Loan growth peaked in February 2021 and has since been slowing, turning negative in January and February 2023.
Mortgage interest rates rising, property price growth slowing
A second factor contributing to reduced lending growth is the ECB’s tightening of monetary policy. Rising interest rates have translated into higher borrowing costs borne by non-financial corporations and households. Mortgage interest rates on new lending have tripled since March 2022. Unsurprisingly, one result has been that the rate of increase of residential property prices has started to decline although remains positive. It should be noted that property prices tend to be inertial and further reduction in their growth rate seems likely.
Public debt declining and yield spread unaffected
After the start of Covid in 2020, public debt surged to 135% as the general government deficit rose to 6%. The debt ratio has since fallen relative to GDP, reaching 114% in 2022 as the deficit was reduced to 3% of GDP in 2021 and to 0% in 2022.
This strong recent fiscal performance is evident from the behaviour of the spread between Portuguese and German 10-year yields. While the spread rose sharply during the GFC and the eurozone debt crisis as investors worried about the sustainability of Portugal’s public finances, it has been well contained since 2020. Notably, it has not risen materially despite the dramatic increase in the ECB’s policy rate since July 2022. This is evidence that the credibility of Portuguese fiscal policy has not been an issue.
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