A tough 2012 but is there light at the end of the tunnel for the Eurozone?
FRANKFURT, 20 March 2012 – Although the Eurozone faces a challenging year with large amounts of public and private sector debt yet to be refinanced, tight credit conditions, further fiscal austerity and more job losses, Ernst & Young’s Eurozone Spring Forecast (EEF) is predicting a slow return to growth in 2013. But the European Central Bank (ECB) has to continue to play a central role by being prepared to cut interest rates further and purchasing government bonds in peripheral countries.
With a default on Greek sovereign debt negotiated and a second bailout agreed, and assuming that policy-makers continue to keep up the momentum by putting a credible firewall around Spain and Italy, EEF is forecasting a mild recessionary fall in Eurozone GDP of 0.5% this year, with nine of the seventeen Eurozone members economies set to contract. However EEF expects Eurozone GDP to grow by about 1% in 2013 before picking up to 2% a year in 2015-16.
Marie Diron, senior economic adviser to the Ernst & Young Eurozone Forecast comments, “Although the recovery from recession is likely to be the slowest in Europe in the last 40 years the actions taken by the authorities over the last few months, particularly the introduction of the long-term refinancing operations by the ECB, have created conditions where it is possible to now see light at the end of the tunnel even if actual recovery is still some way off. These policy efforts have to be rigorously maintained and even reinforced at a Eurozone and national level to ensure we don’t lose momentum.”
Mark Otty, Ernst & Young Area Managing Partner for Europe, Middle East, India and Africa comments; “Despite the turmoil, the majority of large businesses across Europe remain in relatively good financial shape as the past two years have seen them making efficiency savings, improving profit margins and adding cash to their balance sheets. If they have some confidence that stability is returning we could see investment and job creation follow.”
Fiscal consolidation and lack of credit weigh on growth
The main constraints to Eurozone growth this year will stem from fiscal consolidation, which EEF estimates will amount to more than 1% of GDP, and tight credit. Despite the introduction of the long-term refinancing operations (LTRO), which has boosted financial markets and ensured that the prospect of a banking credit crisis has receded, latest data indicates that much of the liquidity provided has not yet been lent on into the wider economy.
Marie explains, “Eurozone banks are still facing difficult financing conditions, at a time when they need to achieve higher capital ratios. As long as banks are not passing on the liquidity borrowed from the ECB to businesses and households, credit conditions will remain tight dampening both investment and consumption. Indeed, there is a risk that credit constraints and fiscal austerity are more severe and protracted than we currently envisage; in this scenario, the Eurozone would experience a deeper recession.”
Lack of consumer and businesses confidence results in rising unemployment
In response to tighter financing conditions, an increase in spare capacity and weaker domestic demand, businesses are likely to scale back investment spending. Spanish and Italian firms are forecast to cut capital spending by 5% or more in 2012, while in France and Benelux investment will remain flat or edge down slightly. Amongst the larger economies, only in Germany is investment spending likely to grow meaningfully but not until the second half of the year.
Despite a moderation in inflation this year (assuming no further rise in oil prices), consumer spending is also likely to be reduced reflecting an uncertain external outlook and deepening fiscal austerity although perhaps by less than might be expected. At the Eurozone level, EEF predicts that growth in consumer spending is likely to be negative at -0.7%. However, German consumers are likely to increase spending by around 1%, while French household spending will remain broadly flat.
This outlook for business investment and consumer spending means job creation is set to weaken in most Eurozone economies. With Germany again set to be one of the few exceptions, EEF forecasts unemployment rates to rise across the Eurozone in 2012 peaking at 18.2 million at the turn of the year, although given the relatively strong balance sheets of many European corporates this trend could be quickly reversed if confidence begins to return.
ECB must continue to play its part to ensure weak recovery
The ECB will continue to play a critical role in 2012 by providing extensive support to the Eurozone economy. Should the economic environment deteriorate, EEF believe this should include lowering interest rates further to 0.5% and stepping up purchases of government bonds to facilitate debt refinancing by peripheral countries at affordable interest rates. Without action, there is a risk of a series of disorderly defaults among weaker countries that could threaten the future of the Eurozone.
Marie comments, “Although the risk of a breakup of the Eurozone has fallen back since late last year thanks to the agreements on Greece and the involvement of the ECB it doesn't mean that we have yet emerged from the crisis. At best, 2012 will be a difficult year for governments, businesses and households alike. Even the weak recovery forecast for next year should not be taken for granted given the substantial problems the region faces over the next 12 months.”
EEF is optimistic however that the Eurozone policy community will tackle these challenges successfully and avoid any permanent structural damage to the currency. Nevertheless, given the impact of the crisis on banks’ balance sheets, and the weakness of public finances in many countries, the recovery will be much slower than after previous downturns.
The scale of current crisis could also be the trigger for Eurozone-wide reforms that would have otherwise been considered too difficult to implement. Real structural change to encourage medium and long term growth to enable the region to compete with developing markets is in many cases long overdue.
Mark concludes, “The Eurozone needs to do more to improve the economic outlook beyond 2013. Tackling rigidities in the labor market, improving the quality of institutions in some countries, taking difficult decisions on the care of ageing populations, and encouraging a single market for services would all go a long way toward improving long-term growth prospects. By taking these steps now, Eurozone governments would also take a big step towards easing the current crisis and help prevent the next.”
Despite the steep rise in oil prices over the past two years, of 30% in 2010 and almost 40% in 2011, Russia’s growth performance has remained disappointing. After accelerating to 4.0% in 2010, year-on-year GDP growth slowed in H1 2011 but then picked up somewhat in H2, in particular Q4, to give full-year growth of 4.3%. There is no breakdown for Q4 GDP yet, but monthly data suggest that both consumption and investment are likely to have continued to strengthen while net trade was once again a drag on growth. We estimate that seasonally adjusted quarterly growth accelerated to 2.2%, although recent indications that full-year 2011 growth may be revised higher (to 4.5%) suggest that this Q4 estimate may be conservative.
The problems in the Eurozone will affect the Russian economy heading into 2102, although the impact will be partly offset by the latest strength in oil prices. Recent data paint a mixed picture with regards to Q1 2012. On the one hand, industrial production data and the manufacturing PMI suggest that industrial growth has only been modest over the past six months given the weakness of global economic activity. But domestic growth remains underpinned by the strength of consumer spending (although retail sales recorded a surprise drop in January), driven by a pre-election fiscal stimulus that probably peaked in December but which will continue to support the economy in Q1 2012.
We expect 2012 GDP growth of about 4%, with the positive surprise in Q4 2011 providing a more supportive base effect and growth now projected to be stronger in H1 this year. The latter is largely driven by the upgrade to our global oil price forecast. However, we expect growth to slow in H2, as a return to higher inflation starts to erode consumers’ purchasing power and weaker global activity weighs on most commodity prices. But if the recent rise in oil prices is sustained through the year, this would mean an upside risk to this forecast.
The pre-election fiscal stimulus continues to drive consumer spending. The government’s targeted balanced budget implied a significant fiscal boost in Q4, which should continue in Q1 this year given announced large wage increases for certain public sector workers such as teachers and the military. But as the spending spree eases and solid growth and high oil revenues boost revenues, a further decline in the fiscal deficit is possible in the coming years. Unless the weaker global economic outlook leads to a collapse in world oil prices, the fiscal position in Russia should remain relatively favourable, in turn enabling state spending and investment to continue to support economic growth in the coming years.
But the rather weaker prospects now seen for Germany and Scandinavia and sharply lower growth in the rest of Europe mean that medium-term growth prospects have deteriorated. And, after a small rise in 2012, the average world oil price is expected to fall in 2013 as weaker global demand more than offsets production concerns in the Middle East. With the boost from high oil revenues and high spending fading, GDP growth is now forecast to slow to 3.3% in 2013, before picking up over 4% in 2014. Over the longer term, the prospect of continued subdued demand in Europe overall, the main market for Russia’s oil and gas, makes it unlikely that growth will return to the levels of 7% or higher seen in 2003-07.
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