H&H asked me yesterday what I thought this year held for the Eurozone, so I thought I’d post today about my views for the year ahead.
In the most part my expectations are that 2013 will be much like 2012 but with different risks in play. 2012 was marked by the ECB’s emergency programs that provided lender of last resort function to the Eurozone banking system which in turn supported sovereign governments. Since then the EU and the ECB have worked together to provide stability mechanism for governments including the yet to be activated OMT. There is no doubt that this combined action has significantly reduce “convertibility” and sovereign risk from the Eurozone but that isn’t the whole story.
As I explained back in September these types of monetary operations are likely to have a limited effect on real economies of nations that are under-going re-balancing and/or attempting to recover from an event caused by rapid depreciation of asset values. What concerns me most is the way in which the re-balancing is taking place within the European periphery where although current account deficits are being reduced it is due to the retrenchment of the domestic economy rather than external sector expansion. What you would hope to see is a rebalancing driven by wage moderation, new investment and production leading to higher exports but this is not what we are witnessing in the Eurozone.
In the southern periphery unemployment continues to rise sharply while industrial production and economic output continue to contract which is having a flow-on effect via tradable sectors to nations that were previously in good economic shape. Quite simply, the fiscal adjustment that is being attempted simultaneously across the Eurozone is slowing internal demand faster than was initially expected and this is manifesting as falling asset values, rising unemployment, rising bad debts and lower than expected government sector revenues.
Even in Germany, the supposed economic powerhouse of Europe, the last GDP figures show contraction:
The German economy was hit hard by the euro zone crisis in the final quarter of last year, shrinking more than at any point in nearly three years as traditionally strong exports and investment slowed, new statistics show.
Gross domestic product shrank by 0.5 per cent in the final three months of 2012, the worst quarterly performance since Germany fell into a recession during the global financial crisis in 2008/2009, and only the second contraction since it ended. The parlous fourth quarter pushed overall growth for the year down to 0.7 per cent, a sharp slowdown from the 3.0 per cent registered in 2011 and a post-reunification record of 4.2 per cent in 2010.
As I’ve been covering over the last few months the downturn is beginning to creep into other AAA rated countries with The Netherlands and France looking particularly vulnerable as we enter 2013. On top of that, all of the original PIIGS, with the probable exclusion of Ireland, still have the potential to miss their existing fiscal targets and that is even after the latest Greek write-downs.
This year we will see renewed fiscal tightening in Spain, Portugal, Italy and France which is again likely to dampen growth. We also have major elections in both Italy and Germany which have the potential to change the political landscape, while the on-going question of what to do about Cyprus and further increases in unemployment creates the potential for “black cygnet” events.
In summary, I expect the Eurozone to continue to contract economically over 2013 with the potential for worse figures than current -0.3% estimate from the ECB. A saving grace would be increased external demand, which will benefit Germany most, but at this stage even this can only be thought of as a mitigating effect not a cure.
Another tough year ahead for the Eurozone.