Upbeat growth and unemployment reports from Spain led the country's stocks to rally on Tuesday, but some economists warned that hopes of an imminent recovery remained unrealistic.
Spain's benchmark stock index, the IBEX 35, traded nearly 2 percent higher after the Bank of Spain released a report that estimated the economy shrank by only 0.1 percent in the second quarter — its smallest decline since it slid back into recession at the end of 2011.
The Bank of Spain's quarterly bulletin is viewed as an accurate indicator of official gross domestic product (GDP) data, which are due on July 30. If the official numbers are in line with this estimate, it will suggest a deceleration in the pace of contraction. Spain's economy shrunk by 0.8 percent in the last quarter of 2012, and by 0.5 percent in the first quarter of 2013.o
"If proven correct, this would be a stronger-than-expected GDP figure, more clearly signaling that the worst of the crisis is behind the country… and, in our view, would be consistent with positive growth for the second half of 2013," Antonio Garcia Pascual, chief euro area economist at Barclays Investment Bank, said on Tuesday.
Meanwhile, Spain's ABC newspaper reported that official data out on Thursday will show the biggest quarterly fall in unemployment since before the economic crisis. Spain's rate of unemployment was 27.2 percent in the first quarter, and analysts expect it to fall to 26.7 percent in the second quarter.
Hopes of an upturn in Spanish corporate activity were also boosted on Tuesday, after the Netherlands' KPN reported that Telefonica was buying its mobile operation E-Plus for 5 billion euros ($6.6 billion).
Nonetheless, Ben May, a European economist at Capital Economics, panned hopes that a recovery was on the horizon for Spain.
"Given these developments we have revised up our GDP forecasts slightly. We now expect the economy to contract by about 1.7 percent this year, compared to our previous forecast of a 2 percent fall. Nonetheless, we continue to think that the consensus forecast for GDP growth of 0.3 percent in 2014 is much too optimistic," May said in a research note on Tuesday.
The Bank of Spain attributed the softening in Spain's economic downturn to strong exports performance, but May said the positive impact was unlikely to last. He forecast that GDP would continue to fall in 2014, perhaps by as much as 1.5 percent.
"We expect weak demand in Spain's major export destinations to mean the boost from the external sector will fade over the coming quarters. And with the fiscal squeeze, housing slump and private sector deleveraging set to continue for some time to come, domestic demand is likely to contract significantly further," he said.
Antonio Garcia Pascual, Barclays' chief euro zone economist, was more sanguine about Spain's prospects, but said the recovery would still be weak.
"Spain is very likely to print some positive growth in the second half of the year. However it is important to remember that the recovery will be very gradual (surely not v-shaped), as the economy is emerging from this crisis highly leveraged and credit constrained," Pascual told CNBC.
Economists also flagged Spain's unstable political situation as a risk to any economic up tick.
"Political stability is being questioned in several of the periphery states at the same time, from Portugal to Spain to Italy…The risk is that political infighting and self-assessment detracts attention from necessary economic adjustments," said Deutsche bank economists Gilles Moec and Mark Wall last week.
On Tuesday, Prime Minister Mariano Rajoy confirmed he will appear before parliament on August 1 to face questions about the corruption scandal miring his People's Party. Rajoy has so far denied any participation in the affair, which involves allegations of a party slush fund and illegal donations.
Moec and Wall warned that Rajoy's authority would be diminished if he is not rapidly cleared of charges, adding: "In general,institutional meltdown will be avoided in Spain, in our opinion. The question is whether a period of self-assessment distracts the government from the job in hand."
Barclays' Pascual added that an abdication by Rajoy would have "incalculable" results for the euro zone.
"While the market is not expecting PM Rajoy to step down or the government to fall (correctly in my view), if that were to happen, the impact of that scenario would be incalculable for Spain and the rest of the euro area," he said.
In the meantime, a wave of Spanish company results out later this week could provide further indication of whether Spain's economy is on the up. Iberdrola will post second quarter numbers on Wednesday, followed by Telefonica on Thursday and Banco Popular and Caixa Bank on Friday.
Jose Wynne, head of FX research at Barclays Investment Bank, said investors should also await further economic data before judging whether Spain was recovering.
"Latent risks will linger, but flash PMI [purchasing managers' index] numbers for July, together with M3 data and the G2 lending survey next week, seem key ahead of the next European Central Bank policy decision," said Wynne.