Europe faces uphill battle

This is the second of a three-part report on IHS Global Insight’s discussion on the Eurozone sovereign debt crisis.

Economic growth in Europe will be sluggish and uneven in 2011, according to Howard Archer, chief European and U.K economist for IHS Global. In a recent webcast, he pointed to the slowdown in the third quarter of 2010 as evidence that the Eurozone will see islands of strength amid a sea of debt-burdened laggards.

“If you look at individual countries you can see that growth has been very much led by Germany,” he said, noting that Austria, Belgium and France have also chalked up reasonable growth.

“In contrast, you can see that Greece has continued to contract. Ireland—despite growing in Q3—is still seeing GDP fall year on year. Italy is seeing pretty muted growth, and Spain is struggling to sustain any growth at all,” he said. “There’s a real mixture between the northern European countries led by Germany… and the southern peripheral countries and Ireland, which are still struggling. This is probably going to remain the situation going forward.”

Archer explained that what recovery there has been is “supported by improved global growth lifting exports; a softer euro (which hit a 4-year low of U.S. $1.1865 in June 2010); very low interest rates (the ECB has kept interest rates down at 1% for an extended period); a generally stimulative fiscal policy across the region; and inventory rebuilding.”

But the “good times” may be coming to an end, as governments tighten their fiscal policy and the sovereign debt crisis maintains pressure for aggressive action. While this kind of belt-tightening is most pressing in Greece, Portugal, Spain, Ireland and, lesser extent, Italy, even the stronger economies, like France and Germany, are expected to step up their fiscal measures.

“Germany is trying to set an example for other countries. Even though its fiscal situation is better, it’s showing that it sees fiscal consolidation is the way forward.”

Eurozone unemployment remains at a 12-year high of over 10%, and Archer expects “it could even edge up a little bit further. It certainly seems very unlikely we’ll see major improvement overall, though Germany is the exception there.”

Along with high unemployment, consumer spending will be reined in by muted wage growth, modestly higher inflation, and declining government spending. Archer expects at least some increase in business investment for 2011.

“I think companies are becoming more prepared to invest to upgrade or replace old capacity and to boost efficiency,” he said. “But the fact that there’s excess capacity in a number of countries means that overall investment growth is likely to be fairly limited.”

Eurozone forecasts Archer says Eurozone growth will be “pretty muted in the first half of 2011.”

“We do expect growth to gradually firm in the second half of this year by a pick up in global growth. But overall we think Eurozone GDP will probably be limited to 1.5% in 2011 and maybe slightly firmer next year.”

Eurozone CPI inflation is “likely to rise slightly in the early months of 2011 after reaching a 26-month high of 2.2% in December 2010, pushed up by food, commodity and energy prices. But we do believe underlying inflation—which was still only 1.1% in December—should remain muted due to ongoing wage moderation and excess capacity.

“That should mean the ECB can hold off raising interest rates in the near term, despite some hawkish comments last week, and then raise rates only gradually once they do start raising them.” Archer sees rates rising to 1.25% in Q4 2011, and expects them to reach 2.50% by end of 2012.

The euro is expected to trade largely in a range between US$1.30 and US$1.35. “But we think it will be prone to sell-offs on a spike-up in Eurozone sovereign debt tensions,” Archer says.

“The extended fiscal tightening that’s going to be needed to reduce budget deficits and public debt levels for many countries is likely to weigh down on eurozone growth over the medium term, as is the need for a number of countries to improve competitiveness through extended wage moderation and lifting productivity. This will be good for the long-term growth of these countries but is likely to lead to limited growth in the near term.”

Archer says the example of post-reunification Germany provides a good model for the Eurozone’s problem countries.

“They underwent an extended period of wages being kept down. That helped to limit consumer spending, but now Germany is reaping the benefits, and hopefully that will increasingly occur in some of the problem countries at the moment.”