Europe’s economies
A false dawn
The recession has been mild so far. But things are likely to get much worse
Jan 14th 2012
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A NEW year can bring a burst of optimism, even in as troubled a place as the euro area. Stockmarkets have been a bit cheerier, helped by better jobs and output figures from America. Bond investors seem less skittish: on January 5th an €8 billion ($10.4 billion) auction of French government bonds was comfortably oversubscribed. The €498 billion that banks were able to borrow cheaply for three years from the European Central Bank (ECB) in December has helped to settle nerves.
The news on the economy has also been a bit better. A closely watched index of business activity, based on surveys of purchasing managers across the euro zone, has risen for a second month in a row. The German economy has stayed resilient despite troubles on the European Union’s southern rim. It grew by 3% in 2011, according to figures from the statistics office this week. Business confidence perked up in the last two months of the year on the gauge published by Ifo, a Munich research group. Unemployment fell in December to 6.8%, the lowest level since 1991.
Yet the figures have not been so perky as to suggest the euro-zone economy will avoid recession. German GDP probably shrank in the fourth quarter of 2011, says the statistics office. French GDP was flat, says its central bank. Add in grimmer figures from Italy, Spain and elsewhere, and euro-zone GDP may have fallen by some 0.3-0.4%. The bright start to the year might mean that the current quarter is no worse than the previous one, but much will depend on whether financial markets remain calm. With so much ahead that could go wrong, the chances of that are slim.
The worries begin with sovereign debt. Barclays Capital reckons that euro-zone governments must raise €218 billion in new bonds in the first quarter, of which €167 billion is needed to pay maturing debt. Some €300 billion of short-term bills must also be sold. Italy will be the largest single issuer: it has two chunks of debt due in the last weeks of January and February. The government is likely to pay a high price for its money: yields on ten-year bonds are close to 7%. A bigger concern is that investors might snub one of Italy’s bond auctions.
That would be less of a worry if the euro zone had a stronger safety net for countries that have fallen foul of bond markets. But the EU summit in December deferred until March a discussion on whether to raise the €500 billion lending capacity of the euro zone’s rescue fund. The standing of the fund relies on the credit of the countries that back it, including France, which is threatened with a two-notch downgrade to its AAA credit rating by Standard and Poor’s. A decision on whether to downgrade all euro-zone government bonds is due before March—one more reason to fear the worst.
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The biggest danger is Greece. The country’s slow-motion bank run has continued (see chart 1). Its central bank has provided emergency liquidity to banks to make up for lost deposits, which have dropped by more than a quarter since 2009. An IMF report on Greece just before Christmas was sobering. It says GDP probably shrank by 5.5-6% last year and may fall by a further 3% in 2012. Deepening recession makes it harder for Greece to meet its budgetary targets. The pace of reform and of privatisation has been slower than hoped. Credit is scarce and dear.
The delay in reaching an agreement with private-sector creditors on the losses that they should bear on Greek government bonds has not helped. The IMF reckons that, if all private bondholders agreed to take a 50% “haircut” (ie, lose half the value of their bonds) and if Greece were to meet its fiscal targets, public debt might eventually fall to 120% of GDP. That is still a heavy burden. The 50% target agreed on at October’s EU summit is the minimum required to make the debt sustainable. Greece has a €14.4 billion bond due on March 20th. A deal is needed soon so that bonds can be exchanged before then for longer-dated ones. A bigger haircut, or one that is not voluntary, would jolt investors. And there is always a risk that Greece might fail to meet its commitments or that it might fall out with its “troika” of rescuers: the EU, IMF and ECB.
Bond-market indigestion; a rating downgrade; the worsening mess in Greece; or the wrangle over private-sector losses: any of these could rattle confidence and trigger a much deeper recession. Even in the absence of an accident, conditions are hostile to growth. Governments are cutting spending and raising taxes to assuage bond investors, as well as their would-be rescuers in Brussels and Frankfurt. Banks are required to meet EU capital-adequacy targets by June. Raising fresh money is proving tricky and so banks are rationing capital by selling assets. They are reluctant to make new loans. All this has taken a toll on confidence, which fell for a tenth month in December, says the European Commission.
The misery is spreading far beyond the euro area. Sweden’s economy rebounded more strongly even than Germany’s in 2010 but is now flirting with recession. Manufacturing fell by almost 2% in November. Sweden’s central bank lowered its main interest rate in December in response to the euro gloom (as did Norway’s).
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In the east industrial production in Poland, Hungary and the Czech Republic has held up surprisingly well so far, says Gillian Edgeworth, of UniCredit. But capital flows—including bank loans from the euro zone—are drying up and countries with large current-account deficits, such as Turkey and Poland, rely on these. Currency weakness is one indicator of the region’s distress (see chart 2). Turkey’s central bank has intervened in the foreign-exchange market and allowed interest rates to rise to support the lira.
What is a worry in eastern Europe is a small blessing in the west and south. The euro’s recent fall against the dollar is helpful to exporters, especially in the struggling periphery (see Buttonwood). Sadly there are many more reasons to be fearful than cheerful about the euro zone.
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