October 25, 2008
Yikes! Euro Area Edition
From the FT today:
Survey underlines grim outlook for eurozone
By Ralph Atkins in Frankfurt, Published: October 24 2008 11:23 | Last updated: October 24 2008 18:37
The eurozone economy contracted sharply in October as the global bank crisis slammed the brakes on business activity and blackened the outlook for the 15-country region, a closely watched survey indicated on Friday.
The steep fall in eurozone purchasing managers' indices, which showed private-sector output falling at the fastest rate since the launch of the euro in 1999, suggested the region was facing prolonged recession-like conditions, which could last well into next year.
But economists warned that the full effects of tighter credit conditions on business and consumers may have yet to feed through, and that expected cuts in European Central Bank interest rates could fail to revive growth.
The "composite" purchasing managers' index, covering manufacturing and services, slumped from 46.9 in September to 44.6 in October, the lowest since the survey began a decade ago.
"The financial crisis has developed rapidly into an economic crisis, with the eurozone economy contracting at the fastest rate for over 10 years," said Chris Williamson, chief economist at Markit, the research company that produces the survey. The indices are regarded as offering a good guide to trends in economic activity, providing a more up-to-date snapshot of activity than gross domestic product data. An index figure below 50 is taken to indicate a contraction in activity.
They showed eurozone manufacturers' new orders fell this month at the sharpest rate ever recorded, led by a slump in export orders. Service sector new business did not contract as fast but still saw the second steepest fall on record. Eurozone employment has fallen for four consecutive months.
The scale of the deterioration suggested several factors had combined into a lethal economic cocktail. Eurozone growth started to slow last year as a result of a stronger euro, higher official borrowing costs and then surging oil and commodity prices. "What I fear at the moment is that you have a natural progression from the downturn that was already in place with the extra hit from the financial market crisis ... It has exacerbated problems that were already there," said Mr Williamson.
The impact of this data can be seen in revisions to the outlook. I don't have access to consensus forecasts for Europe, but I can plot the outlook from DeutscheBank's forecast from yesterday, and from before the financial crisis.
Figure 1: Log real GDP in Euro Area in 2000 Euros (blue line), DB forecast from 5 Sep (green line) and DB forecast from 24 Oct (red line). Source: Deutsche Bank, Focus Europe, 5 Sep and 24 Oct issues, and author's calculations.
So, it seems the world has re-coupled, partly because of common shocks emanating from the financial crisis.euro area, and recession.
Posted by Menzie Chinn at October 25, 2008 08:18 AMdigg this | reddit
Nobody has yet commented this post. It's strange because the European part of the world is crucial for the US economic outlook. Actually the European recession will worsen the American contraction going forward. And the European deterioration is NOW supporting the Dollar. The Euro depreciation might help the German industrial cycle.
Posted by: gion at October 26, 2008 02:37 PM
when is the world going to call out the idiocy that is the ECB? Why Trichet and his moronic associates have the main policy rate in Europe at 3.75% is beyond stupid - it is criminal. All focus has been on dollar rates and dollar LIBOR. People should also focus on EUIBOR. Rates are going up on European corporates while the ECB fiddles.
The ECB says that inflation is still a problem in Europe. But that is only if one looks only in the rear view mirror, and if one really frets about a 3% inflation rate. Going forward, with the soaring Euro and the imploding economies, the ECB will be lucky to stave off deflation!
Now some moron at the ECB is going to give the excuse that if we reduce rates now that the EURO will depreciate and the stimulative aspect of lower rates will be counterbalanced by the damping effect of a higher currency. This completely misses the point that the currency markets already knows that the ECB will have to reduce rates and that the longer they do not, the harder the currency will have to fall to absorb the blow to the economy. I would argue that if the ECB reduced rates dramatically, that this could be accompanied by a rising currency since the world will fear less that Europe would continue to shoot itself in the foot like it is doing now.
In a perfect world the US would also intervene to keep the dollar from appreciating so much against the Euro and other currencies. This obviously makes too much sense for anyone to actually attempt it however.
Posted by: Edward Allen at October 26, 2008 09:29 PM
Gion, the problem is trying to sort out what the purple prose means. Markets always seem to be plunging or soaring, rather than declining or advancing.
If I'm reading Menzie's graph correctly, we're talking about a fairly small decline in per capita GDP. The IMF predicted a small increase.
The greater problem for Europe, I suspect, is in capital formation. They are more reliant on banks for this than we are. Turmoil in the banking system is really bad in that regard.
On the other hand, as far as I can tell, most of the bad paper is inside the US, with some in Europe and a small amount in Asia. My guess is that European governments are not going to have to borrow as much money to stabilize the system as we are and the shocks will not extend as widely through the economy.
Some of the market chaos we are seeing is panic. Some is hedge fund redemptions (probably because of client panic). When it all plays out, my guess is that Asia will be stronger than one might guess and the US will be weaker. Europe has its problems, but I am not sure that I see why they should be as bad as ours.
Posted by: Charles at October 26, 2008 10:14 PM
Charles, thanks for your elucidations. I agree with almost all of your points.
But the bad news for Europe now is that the private firms expectations are seriuosly negative. Specifically the industrial manufacturing sector is extremely pessimistic about the real economy next year.
I hope that Asia might turn out to be stronger than previously assumed (as you pointed out). It will help Europe (and US) going forward.
Posted by: gion at October 27, 2008 04:51 AM
I base my expectations on reserves, Gion. Countries that have large reserves theoretically can run large deficits without deranging the rest of their financial system. Whether they do so or not is a matter of internal politics.
In the case of China, my guess is they have no real choice but to crank up their internal economy. The country already evidences unrest. One way of soothing that is to improve the standard of living. As a command economy, they can do that, at least in the short term.
Japan is another story. Although I am basing this on relatively limited glimpses, I have never seen such pessimism as I see in Japan. And perhaps they have good reason. The LDP, in one incarnation or another, is still in control. I am not much encouraged by the DPJ. Japan suffered a loss of dynamism by the post-war suppression of the left and the later failure of the left to emerge. The DPJ is a complex concoction of center-left to center-right, with nothing much holding them together except a dislike of the LDP. So, Japan seems to me politically incapable at present of responding creatively to crisis.
The oil exporters are the other countries with large reserves. Their surpluses are falling. though, so only some of them will be capable of acting to stimulate their domestic economies, and only some of those economies are significant in size. Furthermore, some (like Brazil) have managed to create banking crises of their own. In Brazil's case, as I understand it, by the banks making bad currency bets, forcing the government to backstop them.
And then there's the United States, which apparently has endless reserves of funny money. As Nouriel Roubini explains it, the means by which the US is creating liquidity can be quickly mopped up if inflation starts to rise. So, he is predicting deflation and stagnation domestically. And a further 30% drop in the market.
Europe is a mixed bag. Northern Europe is in reasonably good shape. Southern Europe, especially Italy, is a mess. It would not be a surprise if the economic part of the European Union unravels. And energy dependence on Russia is a big complication. It seems to be driving Europe to eliminate its petroleum dependence-- which could be a big plus as the world comes out of recession in years down the road.
Posted by: Charles at October 27, 2008 08:49 AM
@Gion: I live in euro country and am perfectly happy with the current ECB rate. Firstly, price stability is the ONLY legal defined objective of the ECB, and not economic growth, and secondly I do not believe that lowering the interest rate will help the economy much anyway. The US has proven it can lead to bubbles, and Japan has shown that even a zero rate does not always help. Building a healthy economy is about other things than an extremely low interest rate.
Posted by: Eric at October 27, 2008 10:33 AM
ERIC: I did not say that the Ecb should lower the rates. I just remarked that things are going really bad in Europe, wherever the repo rate.
I know that an "healthy economy" is based on productivity growth and structural policies.
It is a matter of fact that monetary expansion might turn out only a monetary illusion.
From the Ecb website:
This general principle, referred to as "the long-run neutrality of money", underlies all standard macroeconomic thinking. Real income or the level of employment are, in the long term, essentially determined by real factors, such as technology, population growth or the preferences of economic agents.>
Posted by: gion at October 27, 2008 03:31 PM
The difference betwee tne old DB forecast and the new one is quite small - less than 1/4 of 1%. It looks like the graph was drawn to overemphasize the change.
European banks apparently have very large risky loans to emerging markets that may turn out to be as disastrous as U.S. real estate loans.
Germany will suffer more tha apace from drop in demand for capital equipment worldwide.
Posted by: don at October 27, 2008 05:31 PM
European banks have been reducing their exposure to emerging markets lately (about 1 trilion $) ; this thing is good.
Posted by: gion at October 28, 2008 02:07 AM
don: I just calculated the log difference between the 5 Sep and 24 Oct forecasts. It's 1.7 ppts of GDP by 09Q2. I don't know where you got the .25 ppts, unless you neglected to note that the vertical axis is in log terms...
Posted by: Menzie Chinn at October 28, 2008 04:38 PM
yep. embarrassed to say that is it exactly.
Posted by: don at October 29, 2008 12:43 PM