On the horrendous economic numbers coming out of Europe
The European Union released figures for Q4 2012 GDP today and they were awful. GDP fell by 0.6% in the euro zone and 0.5% in the entire EU, with only Estonia and Slovakia growing inside the euro zone in Q4. Stock markets are getting clobbered on the news and the euro is selling off. This is not unexpected for me as I have been writing a number of articles about different euro zone countries economies underperforming and their governments missing deficit targets. To wit, I am looking more to Europe sovereign bond markets to converge to the downbeat economic reality than to currency or stock markets. The markets to focus on here are Spain, Portugal and France because this is where I see problems for Europe.
Looking at the overall figures, the 0.6% contraction in the fourth quarter in the euro zone is the worst economic contraction in Europe since the beginning of 2009. And so it marks an acceleration of economic decline that should signal to European policymakers that their economic policies are not working. That said, I don’t anticipate this will be the message the data send European leaders.
Something that policy makers are watching is sovereign debt markets. The euro is down at three-week lows to the US on the back of this news. And as I relayed to you last month, euro weakness is highly correlated to the severity of the sovereign debt crisis. This is a major reversal of trend and I believe If the euro remains weak, we should see this as a harbinger of crisis. While I have been saying that I expected a renewed crisis in Europe this year, I have not been saying it was right on the horizon. Now, we have to watch for signs that it is on the horizon and I believe European policymakers will be watching for these signs as well because they are keen to get Ireland off into an OMT program as a sign that austerity has been successful.
Drilling down, the numbers were poor across the board. Even Germany’s domestic economy shrank by 0.6% in Q4 2012. The French economy shrank 0.3% and the Italian economy shrank 0.9%. These are the three biggest economies in the euro zone. The problem here in terms of policy is that economists are positive about the outlook in Germany. They see the figures as a temporary dip for Germany and expect the country to return to growth in 2013. This outlook will definitely impact policy by making Europe more reluctant to see te connection between austerity, poor growth and the sovereign debt crisis.
Of the three large euro zone economies, I am most worried about France rather than Italy. As I outlined yesterday, France has many of the same problems that Italy has in terms of high real exchange rates from an export competitiveness perspective. And while this would necessitate so-called internal devaluation to improve competitiveness given the fixed exchange rates within the euro zone, instituting such a deflationary policy response right now would be catastrophic for the French economy. The most worrying part of the French situation is that the French housing market is overheated and the French banking system is undercapitalised, making any deceleration in the economy perilous as debt deflation could take hold as it has in Spain.
In terms of the periphery, Spain and Portugal are the countries to watch. Let’s look at Portugal first. As El Pais reported earlier today, Portuguese unemployment has hit a post-euro high of 16.9% on the back of an accelerating contraction in the economy. Youth unemployment is now 40%. The austerity in Portugal is accelerating the decline in economic output. In Q4 the quarterly contraction hit 1.8%, up substantially from Q3’s 0.9%. Yet, the latest information is that even the IMF, which elsewhere has talked about back loading its austerity regime, is still committed to front-loaded austerity in Portugal. They have told the Portuguese that the most draconian budget in Portuguese democratic history won’t be enough. They want more cuts in 2013. Ostensibly, the reasoning here is that with Ireland on the verge of OMT status, Portugal needs to get there too and they cannot do so based on the present numbers. So, despite the hardship that front-loading austerity represents, the IMF is doubling down on this strategy in the hopes it will allow Portugal to exit the Troika programs into an OMT-style bailout. I believe this strategy will fail and Portugal will not make its targets as the economy and tax receipts decline.
Spain already released it’s Q4 GDP numbers two weeks ago and this showed the Spanish economy contracting 0.7% in Q4 2012. The numbers prompted Spanish Prime Minister Mariano Rajoy to call for German domestic stimulus and a relaxation of Spanish deficit targets. In my view, given this economic backdrop, the only reasons that Spanish bonds are performing adequately is the implicit OMT backstop and the search for yield amongst bond investors. The economy in Spain is not getting better, deficits are still large, and government debt is still rising. I expect the bond yields to move to meet the reality of the economy rather than the other way around and the decline in the euro may be just the sign that this process is now beginning.
Comments are closed.