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Europe — Debt troubles will create a two-speed Eurozone

16 April 2010

According to the latest Eurozone Forecast Spring 2010, published today by Ernst & Young, countries in the Eurozone started to emerge from recession earlier than many other major developed economies.

Germany and France returned to positive growth in 2009 Q2, ahead of the US, with the Eurozone as a whole growing again by Q3 while the UK only exited recession at the end of last year.


However, the Eurozone recovery is now stuttering and the economy faces significant headwinds that have been compounded by the Greek financial crisis. Gross Domestic Product (GDP) growth fell back from +0.4% in 2009 Q3 to zero in 2009 Q4.

Recent business and consumer surveys have been mixed, both across surveys and countries. As a result, Ernst & Young expect Eurozone GDP to rise by only +0.1% in 2010 Q1.

The end of the car scrapping scheme, for instance, brought consumption forward from 2010 to 2009 and this is depressing car sales now (passenger car registrations were down more than -9% in January and only recovered mildly in February). In addition, the unusually cold weather also will have reduced activity at the end of last year and in early 2010. Growth in Germany is particularly vulnerable to this factor.

The initial turnaround from recession in the middle of last year was generated by four main factors:
  • a stabilisation in global financial conditions
  • a strong rebound in foreign demand, especially in Asia
  • a turn in the inventory cycle
  • support from expansive fiscal and monetary policy
All these factors will continue to support growth across the Eurozone as a whole through the rest of this year, even though economies such as Spain, Ireland and Greece face a tough adjustment as a result of their previous excesses.

International trade will be the main source of recovery as growth in emerging Asia and the US picks up strongly. Ernst & Young forecast net trade to contribute 0.7% point to Eurozone growth in 2010, thereby accounting for three-quarters of the rise in overall GDP. Exports are forecast to rise by more than +4% this year as demand in the Eurozone's main export markets increases by around +9.5%.

While exports are expected to pick up, this forecast still implies that Eurozone companies will be under-performing in world markets, losing significant market share.

In particular, the overall strength of the Euro means that Eurozone companies are struggling to compete in key markets.

Although the Euro has fallen from the highs it reached against the US Dollar in early 2008 and has been weakening this year in the wake of the Greek financial crisis, Sterling and key Central and Eastern European currencies have been even weaker.

This means that in effective terms, i.e. weighting together currencies based on countries' relative trade importance for the Eurozone, the Euro is around 16% above its long run average. And in real terms, the Euro is close to its historic peak.

Domestic demand is also expected to rise across the Eurozone in 2010, having fallen in 2009, by -3.3%. Demand is underpinned by an aggregate fiscal stimulus across the Eurozone this year equivalent to around three quarters of a percent of GDP, after around 1% of GDP in 2009, and monetary policy that remains very expansive.

It should be highlighted that a similar policy stance has stimulated a much more rapid recovery in the US, where GDP is expected to rise by +3.4% this year. In contrast, the Eurozone economy will struggle to achieve GDP growth of +1% in 2010 and +1.6% in 2011.

 

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