Thursday, September 15, 2011

The Eurozone's Shrinking Economic Growth Predictions

With the debt issues facing a rather large handful of the Eurozone Member States hitting page one of many of the world's mainstream media newspapers, I thought that I'd take a look at the most recent economic forecast for Europe provided by the European Commission.  Their Interim Forecast for September 2011 suggests that all is not well in the Eurozone as far as projected economic growth is concerned for the second half of 2011.

The EC projects that economic growth is expected to come to a standstill in the second half of this year but is not expected to result in a double dip recession.  For the entire year, GDP growth is forecast to be 1.7 percent with third and fourth quarter growth falling to 0.2 percent, revised downward by 0.2 and 0.3 percentage points for the aforementioned quarters.  Here is a graph showing the quarter-over-quarter growth since 2007:

Notice that quarter-on-quarter growth for 2011 is well under the growth levels experienced in the Eurozone prior to the Great Contraction.  After quarter-over-quarter growth rates reached 0.8 percent in Q1 2011, it fell to a paltry 0.2 percent in Q2 2011 with a pronounced drop in exports which were down from 2.2 percent quarter-over-quarter growth in Q1 to 0.6 percent in Q2 because of weakening global trade.

Here is a graph showing the negative change in growth levels for several EU member states from the first half of 2011 to the second half of 2011:

Notice how widely the economic growth rates vary across the EU.  Notice as well that Italy is projected to have near zero growth for the second half of 2011, well below the EU average.  This should be of great concern since Italy has the world's third largest nominal sovereign debt and is being pressured to adopt austerity measures in order to prevent default.

Tension within the banking system is rising.  The three month LIBOR (London Interbank Offered Rate) OIS (Overnight Index Swap) has risen by 75 basis points and is at its highest level since the spring of 2009 when the merde really hit the fan.  Overnight deposits with the European Central Bank have risen to over 150 billion euros in early September, indicating that banks are not lending to each other.  This indicates that there is mistrust within the banking system similar to what was seen during the Great Recession.  This is NOT a good sign.

On the upside, the EC expects that consumer price inflation should drop very modestly over the second half of 2011 as energy prices moderate somewhat as shown in this graph:

In contrast, the United Kingdom is expected to have higher inflation that originally projected since increased energy prices are due in the second half of 2011.

Unemployment is expected to remain stable at about 9.5 percent in the EU and 10 percent in the euro area, only slightly lower than last year.  Once again, changes to unemployment levels are anticipated to vary widely across the EU with Germany showing the most improvement and Spain showing the least.  Employment prospects are not expected to improve over the second half of the year.  Here is a graph showing the changing unemployment levels for the EU, euro area and a smattering of Member States:

Let's take a brief look at the prognostications for two of the EU Member States that reside at opposite ends of the fiscal spectrum.

Germany experienced rapid quarterly growth in Q1 2011, with real GDP growth of 1.3 percent on a quarterly basis.  This dropped to 0.1 percent in Q2 2011, partially due to the impact of shuttering nuclear power plants.  Over the full year, German real GDP growth is expected to reach 2.9 percent.  Moderation in growth is expected for the second half of the year and consumer sentiment has dropped because of increasing uncertainty over Eurozone debt levels.

Italy noted very modest real GDP growth of only 0.1 percent in Q1 2011 followed by real growth of 0.3 percent in Q2.  Real GDP growth for the second half of 2011 is expected to be flat with year-over-year growth of only 0.7 percent, a downward revision of 0.3 percentage points.  Recent issues in the country's bond markets will increase costs for corporations looking to finance expansions and will likely affect their investment decisions.  Consumer sentiment has fallen markedly over the past few months as well, affecting private consumption levels.

When I look at prognostications involving economic growth, I always keep in mind that GDP growth numbers, in particular, are lagging indicators that are subject to frequent revisions.  In this past quarter, growth rates in many EU Member States, Canada and the United States have been surprisingly low, far below what economists predicted earlier this year.  My uninformed guess is that the growth numbers for the second quarter of 2011 will be revised downward and that we are most likely experiencing an economic contraction, if not now, by the second half of 2011.  This could well make the sovereign debt issues facing nations like the PIIGS members reach the critical point.

I find it most interesting to see the economic diversion among the founding nations within the EU umbrella.  Perhaps it really was a state experiment destined to failure.  Only time will tell and I suspect that we'll find out sooner rather than later whether the EU will remain a world economic force.

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