Euro zone: No escape from recession

Resolution of the debt crisis will be the main theme in 2012. Weakening growth prospects, delayed reforms and political challenges imply that a Greek exit from the euro zone is a distinct possibility. However, a break up of the whole euro zone is still unlikely but success depends on continuing support from the ECB combined with national adjustment programmes and further steps toward a fiscal union. Although there have been some encouraging economic data lately (PMI Composite, German Ifo, German unemployment) the euro zone is unlikely to avoid a recession. Indicators clearly point to a fall in economic activity. A deteriorating labour market combined with further increases in austerity measures in several economies imply that private consumption will decrease in 2012. However, the weakening of the euro should provide some welcome support through export stimulus. GDP forecasts for the euro zone have been revised downwards slightly compared to Nordic Outlook November. GDP is forecasted to fall by 0.6 per cent in 2012 followed by a weak recovery of 0.7 per cent in 2013. Inflation decelerated to 2.8 per cent in December. The decline was mostly due to lower food and energy inflation. Inflation is expected to continue to moderate and HICP inflation is expected to be close to the ECB target in 2012 but below target in 2013. ECBs programme to intervene in the secondary government bond market is likely to play a more important role for monetary policy than cuts in the refi rate. Further cuts in the refi rate will have little stimulative effect. Compared to the US, the ECB lends a lot of cash to banks but has so far bought relatively little sovereign debt. We expect the ECB to leave the refi rate unchanged during the forecast period. The ECB is expected to continue to intervene in bond markets but without removing the uncertainty regarding future bond purchases. Andreas Johnson, SEB Economic Research andreas.johnson@seb.se +46 8 763 80 32 GDP forecasts
Per cent 2011 Euro zone France Germany Italy Spain
Source: SEB Key data Percentage change

THURSDAY 12 JANUARY 2012 Growth

Inflation

Labour-market

2012 -0.6 -0.4 0.3 -1.6 -1.0

2013 0.7 0.7 1.2 0.3 0.3

2010 2011 2012 2013 GDP* Unemployment** Inflation* Government deficit***

Source: SEB

1.5 1.6 3.0 0.4 0.6

1.8 10.1 1.6 -6.4

1.5 10.1 2.7 -4.4

-0.6 10.6 1.9 -3.7

0.7 11.1 1.4 -3.2

* Percentage change, ** Per cent of labour force, *** Per cent of GDP

Economic Insight

INDICATORS AND GDP Some indicators such as the composite purchasing managers index (PMI) and the German Ifo-index have rebounded slightly or stabilized. However, other indicators such as the ESI (Economic Sentiment Indicator) and Manufacturing confidence have continued to worsen. Most indicators are at levels indicating a fall in activity. Both the ESI and the PMI Composite now points to a fall in GDP. Manufacturing confidence points to a fall in industrial production. Confidence is weakening in the service and retail trade sectors. The euro zone is entering recession and negative growth is expected during Q4 2011. GDP growth has been revised downward slightly compared to Nordic Outlook November. GDP is expected to fall by 0.6 per cent in 2012 followed by a weak recovery of 0.7 per cent in 2013. As for individual economies, Germany is expected to be the best performer among the Big Four, narrowly escaping a recession. GDP is expected to fall in France, Italy and Spain in 2012.

Economic Insight

LABOUR MARKET AND INFLATION Unemployment was unchanged at 10.3 per cent in November but the number of unemployed increased by 45 000 and reached 16.4 million for the euro zone as a whole. We expect the labour market to weaken further in 2012. The German labour market is still strong; the rate of unemployment declined to 6.9 per cent in September. However, the labour market is expected to turn worse in 2012 as German economic activity slows to a crawl. The French labour market has so far been resilient while the Italian labour market has begun to weaken. There are signs of stabilisation in Ireland but Greek and Spanish unemployment is soaring. Spain alone contributes close to a third of the total number of unemployed in the Euro zone. Inflation decelerated to 2.8 per cent in December from 3 per cent the preceding month. The decline was mainly due to lower food and energy inflation. Inflation will continue to moderate as the euro zone enters recession and HICP inflation is forecasted to end up at 1.9 per cent this year and 1.4 per cent in 2013. Core inflation will bottom out slightly above 1 per cent in autumn 2012 and reach 1.5 per cent by the end of the forecast period.

Economic Insight

FINANCIAL AND MONETARY INDICATORS Yield spreads remain elevated, particularly in Greece. Ireland is well on track with its austerity program and a better growth outlook than the other GIIPS-economies resulting in shrinking spreads. Diverging performance among the euro zone economies implies that the ECBs programme to intervene in the secondary government bond market allows for better differentiation of monetary policy stimulus across economies than cuts in the refi rate. The effect of further cuts is doubtful since it pushes the EONIA rate down towards zero. Compared to the US, the ECB lends a lot of cash to banks but has so far bought relatively little sovereign debt. We expect the ECB to leave the refi rate unchanged during the forecast period. The ECB is expected to continue to intervene in bond markets but without removing the uncertainty regarding future bond purchases. Stress in the European banking system has diminished somewhat since late November but spreads are still very wide compared to the US. Bank lending is decelerating and a further slowdown is expected. The euro has depreciated by around 10 per cent against the USD since late October. The weakening should provide some stimulus for exports. The stock market has recovered somewhat from the latest bottom in late November.