There are moments in the financial markets when, abruptly, the conventional
wisdom among investors about where the global economy is, and where it is
headed, gets severely disrupted. Last week was one of those moments.
All at once, a raft of preconceptions about the state of the world economy and
its prospects was thrown into a state of flux, sparking seismic upheavals
across the financial markets.
The catalyst for last week's drama was the realisation that the outlook for
key industrial nations, and the global economy as a whole, had become much
darker than previously imagined.
A double whammy of bleak news came from the eurozone and from Japan, with
official figures revealing that both economies shrank in the second quarter.
The figures shattered the misplaced assumption by many participants that the
worst of the financial and economic trauma besetting America and Britain
could remain largely confined to the Anglo-Saxon world. The entire developed
world was shown to be teetering on the brink of recession.
Developments in the eurozone most disrupted the slightly complacent consensus
in the markets. An admission earlier this month by Jean-Claude Trichet, the
President of the European Central Bank, that the eurozone had been caught
out by the pace of deterioration in conditions in the 15-nation bloc had
caused some concern among investors. However, Thursday's confirmation that
gross domestic product (GDP) in the eurozone economy had fallen in the
second quarter by 0.2 per cent, its first contraction since the inception of
the single currency in 1999, forced many investors into a drastic
reappraisal.
With the eurozone's annual growth rate also cut to an anaemic three-year low
of 1.5 per cent - less than half the pace set 18 months ago - the illusion
that Europe could remain if not immune then at least substantially insulated
from the economic woes afflicting the United States in the wake of the
credit crisis was destroyed.
The big question now confronting the markets and policymakers is how much
worse things in the eurozone might become.
The optimists among investors appeared to be determined last week to cling to
the few remaining grains of comfort.
Hopes were pinned on the possibility that the decline in GDP might in part
reflect “payback” for the bloc's full-blooded 0.7 per cent expansion in the
previous three months, which was markedly stronger than anticipated.
There is some evidence in Germany, at least, where the economy contracted by a
painful 0.5 per cent in the second quarter, that the period was, indeed,
weak as one-off factors that boosted performance in the previous three
months unwound.
In particular, exceptionally warm weather is thought to have boosted
investment spending in the first quarter, when this surged by 3.7 per cent.
This was helped on its way by a scramble by companies to escape adverse tax
changes on accounting for depreciation.
As Capital Economics notes, this made it inevitable that investment would drop
back sharply in the second quarter and would drag overall growth down with
it.
Yet while these and some other caveats are valid as far as they go, they are,
in reality, to clutch at straws.
Unfortunately, it seems all too apparent that, while Germany's fortunes look
less fragile than those of some of its neighbours, the eurozone economy as a
whole is increasingly frail.
A slew of indicators regarded as reliable guides to the evolving trend in the
eurozone suggests that the bloc is almost certainly embarked on a severe and
protracted downturn.
In recent weeks, key barometers of business confidence plunged alongside
purchasing managers' gauges of present conditions in the eurozone's
manufacturing and services sectors.
Activity across much of the bloc is faltering as the economy is buffeted by a
further tightening in lending conditions induced by the credit crunch, the
squeeze on households' and businesses' finances from soaring food and energy
costs and a toll on exports from the continuing strength of the euro -
despite the dollar's recent resurgence.
The impact is clear from individual national economies.
In France, growth in consumer spending in the second quarter tumbled to its
lowest levels in a decade at only 0.1 per cent, fuelling a much worse than
expected 0.3 per cent drop in GDP in the period.
In Italy, GDP also shrank by 0.3 per cent in the period and worse still is
expected to follow.
In Spain, unemployment is soaring and growth in the second quarter tumbled to
a 15-year low of only 0.1 per cent, as the country's housing boom implodes,
leading to ministers being summoned back from summer holidays to agree
emergency measures.
Less widely recognised is the financial fragility of much of the eurozone's
corporate sector, which leaves many businesses badly placed to weather the
gathering storm and which is highlighted by Michael Saunders, of Citigroup,
in his latest analysis.
Mr Saunders points to figures showing that the gap between eurozone
non-financial companies' spending - including investment and interest costs
- and their profits is in deficit to the tune of 4.6per cent of value added:
the worst figure since early 2001.
Although, on these measures, German companies are still in surplus, the
deficit for Italian businesses last year was 7.4 per cent, the highest since
1992; French companies were in the red by 8.2 per cent, the highest since
1982; and the deficit for Spanish companies was an unprecedented 18.6 per
cent.
All of this leaves eurozone businesses exposed, and likely to severely
retrench, if the deepening downturn further undercuts profitability.
Already, about two thirds of revisions to eurozone companies' profit forecasts
during the first half of the year saw expectations downgraded. It is
difficult to escape the conclusion that the eurozone is confronting a slump
that very likely will prove to be deeper and more prolonged than many had,
until now, expected.
Where, then, does this leave the global outlook? Unquestionably, Europe's
plight makes prospects look still more precarious.
Yet the reappraisal that last week's shocks forced upon the markets offered at
least a glimmer of hope, sending the sky-high prices of oil and other
commodities plummeting.
A continued retreat by commodity prices would offer at least some chance of a
limit to the scale of the global downturn that is now clearly taking hold.
It is clear, though, that a tipping point looms.
Donna Walker: we don't know what would have happened to these economies, hadn't the euro been introduced. I can assure you that without the Euro, Italy would have become Argentina 2.
Horace, Florence, Tuscany, Italy
It is difficult enought to manage one economy, only the inflated egos of the eurocrats believe they can manage the fifteen in the eurozone. when the euro was introduced i gave it ten years, i see no reason to change my mind. One size does not fit all.
john locke, la roche, france
I have never been able to understand how this 'one size fits all' Euro currency was going to work without the harmonisation of taxation and spending in participating EU countries.
I feel sorry for the Germans whose well managed economy is being dragged down by the likes of Italy and Spain.
Edna Burbirdge, Engreve, France
"In particular, exceptionally warm weather is thought to have boosted investment spending in the first quarter..."
why would warm weather increase investment?
david, london, uk
Quite so John Carr of " Nayland"
The difference is that here in "Thankgodwedidnotland` our remedies are within our control and influence"
We cannot blame others "It concentrates the mind". We have to accept responsibilty a virtue not altogether accepted in "Notmeguvland"
Peter Bolt, Redditch, UK
Yes Peter Fieldman, it will lead to greater regulation. This has (hopefully) been a major turning point.
We need the regulators to force the banks to declare their losses and recapitalise very quickly (to enable people to borrow again). We will also need lower interest rates!
Alistair Nicholls, Manchester, UK
The pound is still very close to its lowest ever against the Euro. This recent poor news from the Eurozone has made no difference at all. I would have thought that this would have been worth some explanation.
John Carr, Nayland,
A structured sub prime loan on Wall Street leads to repossessions in England and starving children in Africa. Will this be a lesson to Governments to regulate the finanancial markets whose speculation and greed have brought the world's economies and many of its people to the brink of disaster
peterfieldman, paris, france
As the northern economies of Europe contract, both in & out of the Eurozone, people will economise where they can. The southern 'holiday' destinations are seeing a downturn in bookings & this will escalate. Winter holidays will be cut back & next year's summer will be harder still. Recession looms.
Donna Walker, Effingham, England
No one currency (the Euro) can stand that spread of deficits(and worsening) for long. In the good old days it was handled automatically by currency re(de) valuations. Not possible now.
Do hope there is not another war as that is the 'natural' conclusion to falling comparitive standards of living.
Robert Swift, Chelmsford, Essex.,