Clouds gather over eurozone economy toward year’s end

With persistent turbulence on financial markets this year, with a surging euro and rising oil prices, clouds are gathering over the economy of the 13-nation bloc sharing the same currency, and it appears clear that a slowdown is just around the corner.

Following a strong recovery in 2006, the best performance since 2000, the eurozone economy appeared well on track at the beginning of this year, with the growth rate at a higher-than-expected 0.8% year-on-year in the Q1. Private consumption, a main booster behind the current upturn cycle of the eurozone economy, lost some steam due to a value-added tax (VAT) rise in Germany, the largest economy in the bloc. However, robust investment helped the economy move on. Encouraged by Q1 figures, the European Commission, the European Union’s executive arm, in May raised its forecast for economic growth for this year. According to the commission’s spring forecast, the eurozone economy was expected to grow by 2.6% in 2007, half a percentage point higher than a previous forecast released in November 2006. „The European Union and the euro area remain on a brisk growth path that should reduce the unemployment rate and the average public deficit further to levels not seen in a long time,” the EU Economic and Monetary Affairs Commissioner Joaquin Almunia had said.

Enthusiasm soon withered in view of the Q2 results. The growth rate dropped to 0.3% quarter-on-quarter, the lowest level since early 2005. The moderation was mainly due to sluggish investment, and could, at least partly, be explained by temporary factors such as the return to normal levels of construction investment, which were boosted by the unusually mild winter weather at the start of the year. A rebound in the Q3 proved to be not powerful enough to boost optimism. In August, a crisis in the US subprime mortgage market proved to be a major risk to the eurozone economy, which was also under increasing pressure from a stronger than ever euro and record-breaking oil prices. The eurozone economy fell into uncertainty for the rest of the year, while it became more certain that the peak of the economic cycle had passed. In its autumn forecasts after the US subprime mortgage market crisis, the European Commission lowered its projection for economic growth for the eurozone for 2008, from 2.5% in spring forecasts to 2.2%.

Financial turmoil, triggered by the US subprime mortgage market crisis, rising oil prices and a surging euro were cited as major risks ahead. „Clouds have clearly gathered on the horizon,” Almunia said then. „Economic growth is becoming more moderate and the down-side risks have clearly increased.” The turmoil has already reduced investors’ appetite for risks and has tightened financing conditions. Uncertain about the scale and location of financial losses, banks have been reluctant to lend, creating the so-called credit squeeze. A quarterly report on the eurozone released by the commission has shown that while the effects of the turmoil have so far been largely confined to the financial sector, there are signs that the rest of the economy could also be affected. Banks have tightened their credit conditions to non-financial corporations, households and businesses, while consumer confidence has weakened significantly since the summer. According to financial market estimates, the losses related to rising default rates in the US mortgage market are now expected to amount to $250 to 500 billion, much higher than an earlier expected range of 50 to 100 billion.

Four months after the financial turmoil began, Almunia acknowledged that there was still „no end to the volatility in sight,” warning the persistent uncertainty has resulted in „a general collapse of confidence.” He even suggested that the eurozone economic growth may slow further to 2% or even lower next year. The economy is also under increasing inflation pressure. The eurozone’s annual inflation, pushed by soaring food and oil prices, shot up to 3.1% in November. The commission expects inflation would remain high in the coming quarters, but should fall back to around 2%, a ceiling preferred by the European Central Bank, by mid-2008. Analysts said this would put the ECB in a dilemma as to whether to raise its eurozone benchmark interest rate to maintain price stability since the Frankfurt-based bank has to take care of an economy already hurt by the financial turmoil and be cautious of any move, which may lead to further appreciation of the euro against the US dollar.

The euro has gained 8.3% against the US dollar this year on concerns that the mortgage market crisis would drag the world’s largest economy into recession. The soaring euro is making European exports less competitive. Private consumption, which is taking over as the main engine of growth, was expected to grow at a healthy pace, underpinned by relatively sustained employment growth. The EU as a whole was predicted to create eight million new jobs over the period of 2007-2009, on top of the 3.5 million already created in 2006. This will help reduce EU unemployment to 6.6% in 2009. However, despite the slowdown in the United States, the commission expressed confidence that EU growth will continue to be supported by a solid outlook for the world economy, especially emerging economies. (people.com.cn)