Two-Track Europe and Thoughts On Euro Zone Growth

By Win Thin

It’s a tale of two euros when it comes to growth in that region.  Q4 euro zone came in at 2.0% y/y, slightly weaker than expected and up slightly from 1.9% y/y in Q3.  However, the variance within the major euro zone countries is striking.  Greece was the worst, with GDP contracting -6.6% y/y vs. -4.6% y/y in Q3, while Germany was the best, with GDP up 4.0% y/y vs. 3.9% y/y in Q3.  In the core, we had Austria GDP up 2.7% y/y vs. 2.5% y/y in Q3, France GDP up 1.5% y/y vs. 1.7% y/y in Q3, and Netherlands GDP up 2.4% y/y vs. 1.9% y/y in Q3.  Belgium GDP has not been reported yet for Q4, but grew 2.0% y/y in Q3.  In the periphery, Italy was the strongest with GDP up 1.3% y/y vs. 1.1% y/y in Q3, followed by Portugal GDP up 1.2% y/y vs. 1.4% y/y in Q3 and Spain GDP up 0.6% y/y vs. 0.2% y/y in Q3.  Ireland GDP has not been reported yet for Q4, but contracted -0.7% y/y in Q3.

Two things are very striking.  The first is that Greece GDP contraction is ongoing and accelerating, as Q4 was the ninth straight quarter in a row of y/y contraction and the worst.  This is extremely rare, as base effects typically prevent y/y contractions from extending much past a year.  Even during the Asian crisis, most countries experienced only 3-5 straight quarters of y/y contraction, though Thailand was the outlier with 8 straight.  Given that the Q4 reading for Greece is the worst so far during this cycle, it appears likely that several more quarters of contraction are going to be seen.  Since Ireland followed Greece by 7 months in terms of a bailout and austerity programs, there is clearly a risk that Ireland GDP takes a turn for the worst in 2011.  And if Portugal is forced into a rescue program, austerity measures there may tip that economy back into recession too.

The second thing of note is that the divide between the periphery (here defined as Greece, Ireland, Portugal, Spain, and Italy) and the core (here defined as Belgium, France, Germany, Austria, and the Netherlands) remains wide.  Average Q4 growth for the latter was 2.7% vs. -0.9% contraction for the former.  Most of the core countries are growing close to what they were in Q1 07, as the average gap in Q1 07 vs. Q4 10 growth rates was about -1.2 percentage points.  For the periphery, things are not so rosy and the average gap in Q1 07 vs. Q4 10 growth rates was about -5.2 percentage points.  This underscores the point that we continue to make, that without growth, the periphery is doomed to eventually having to restructure their outstanding debt and this remains our base case scenario for Greece, Ireland, and Portugal.  These peripheral countries are simply not growing fast enough to pay such onerous borrowing rates.  Portugal 10-year yield has been above 7% for 8 straight days and 13 of the past 16.  What’s worse is that 10-year yields for Greece and Ireland are not significantly lower after both getting rescue packages.