EY Eurozone Forecast foresees a two-speed Europe

Brussels, 23 June 2010. The eurozone is slowly recovering from the economic crisis, with an expected growth of 0.8% in 2010 and 1.3% next year. In the meantime, however, an ever-deeper gap is developing between Northern and Southern Europe. The southern countries will have to brace themselves in order to avoid a "lost decade", while the northern countries enjoy more favourable prospects, thanks to their stronger competitiveness. Although forming part of the latter group, Belgium must be unrelenting in its effort to clean up its government finances. The data come from the ´Eurozone Forecast´, the quarterly economic report of EY.

The latest edition of the Eurozone Forecast is the second in a series of new quarterly previews from EY. It was prepared in collaboration with Oxford Economics and is based in part on the methodology of the European Central Bank. For the Belgian edition, Geert Noels, CEO of Econopolis and independent economist of the EY Eurozone Forecast, offers his comments.

Growing gap between Northern and Southern Europe 

With expected growth of 0.8% this year and 1.3% in 2011, the economic recovery of the eurozone now appears to be slowly but surely commencing, yet the situation remains precarious. Employment remains more than problematic, with an anticipated peak of 16.8 million unemployed in the eurozone at the beginning of 2011. Although business investments should increase moderately in 2011, it will be at least 2015 before they regain their level from before the crisis. Moreover, anaemic growth in consumption of 1% to 1.8% is expected for the same year.

A trend which was already highlighted in the first Eurozone Forecast now appears to be taking ever more concrete shape: Europe is becoming a two-speed economic region. While the GDP in the most important countries in the north of the eurozone (Germany, France, Netherlands and Belgium) is expected to rise by an average of 1.7% per year from 2010 to 2012, an increase due primarily to their strong competitiveness, the Eurozone Forecast predicts a negative growth of -0.1% per year over the same period in Southern Europe. Greece, Spain and Portugal are unlikely to see their economic activity return to pre-crisis levels before 2014.

Geert Noels, CEO of Econopolis and independent economist from the EY Eurozone Forecast: "Southern Europe is confronted with significantly lower growth and greater budgetary difficulties. This is becoming a divisive factor within the monetary zone, one which can only be neutralised with difficulty. It is true that the European rescue operation offered financing for the southern countries, but not competitiveness - and thus no growth potential. "

Euro loses ground and interest rates remain unchanged 

The Eurozone Forecast expects that, by the end of next year, the euro will have fallen to USD 1.05, and only then will it rise slightly as growth in the eurozone increases. De facto this means that by the end of 2011 the euro will have lost 20% of its value compared to its peak value at the beginning of 2010.

Given the less favourable growth prospects and the absence of inflationary risks, the Eurozone Forecast expects that the European Central Bank will not change interest rates until mid-2011.

Belgium: domestic demand picks up in 2011 

In 2010 the Belgian economy will grow at a modest rate of 1.4%. Domestic demand remains soft against a background of weak job markets and significant excess production capacity. It is exports that will have to help promote growth in the short term, given that they are benefiting from rising global demand and a weaker euro.

Domestic demand will improve in 2011. Next year consumption should rise by 1.7% and, with excess capacity gradually disappearing by then, it is expected that in 2011 there will at last be greater investment once again. The expected increase in GDP for 2011 is 2.0 %.

Belgian public finances weaken 

The financial crisis and the recession have significant weakened Belgian government finances. The budget deficit rose from 1.2% of the GD P in 2008 to 6% in 2009. Government debt climbed from 84% of GDP in 2007 to 98% in 2009. That is the third highest debt level in the eurozone, after Greece and Italy.

Until now Belgium has succeeded in not provoking the scepticism of investors. Only at the beginning of June did bond spreads rise significantly, when the countries of the eurozone infected one another once again and the auctions of Belgian (and Austrian) government securities encountered greater difficulties. According to Oxford Economics, the fact that the market ultimately did not punish Belgian bonds can be attributed to a closer examination of Belgium´s fiscal situation, which appears to be less alarming than that of the other economies with high debts in the eurozone. First and foremost, the increase of the budget deficit in 2009 was partly the consequence of cyclical factors. Furthermore, Belgium has a good reputation for fiscal discipline. In other words, there is confidence that the government will be able to successfully shrink the recently-increased debt burden once again. The country also has a current account surplus, and is able to finance its debt internally.

No room for a long impasse 

Given the recent political crisis which led to the fall of the governing coalition and to early elections, the greatest danger is that a political standstill will endanger the fiscal efforts being made. Should this erode the confidence of investors, it would harm the solid repayment plan provided for the coming five years. How the political crisis will influence the economy remains one of the most crucial questions for the coming months.

Gust Herrewijn, Managing Partner of EY Belgium, concludes as follows: "A political impasse is not an option at this point. It is of vital importance that the necessary measures be taken now in order to limit the budget deficit and reduce the debt burden, however painful that may prove to be. If investors lose their confidence, that will hurt the debt rescheduling - which then becomes more difficult and more expensive."

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