Euro Zone: Recession Likely Despite Greek Bailout

The final GDP revision is in! For the fourth quarter of 2011, euro zone’s economy absolutely and indubitably shrank by 0.3%.

According to the raw data, spending was the major cause of the downturn. Consumer and public consumption were reported to have fallen by 0.4% and 0.2% respectively while gross capital formation shrank by 0.7%. The under-performance of the trade sector also contributed to the negative figure. Imports tumbled by a whopping 1.2% while exports declined 0.4%.

I have this bad feeling in my bones that this isn’t the last time we’ll see a negative figure. This quarter, we’ll probably see the euro zone finally fall into a recession. Below are my top three reasons:

1. Disappointing Leading Indicators

The most recent Markit Euro zone Composite Flash Purchasing Mangers’ Index (PMI) failed to meet the market forecast by printing a read of 49.4 for the services sector and 49.0 for manufacturing sector. They were also both below the critical 50.0 figure – the level that divides contraction from growth.

This is a significant development because the Flash PMI is considered one of–if not–the best leading indicators of economic growth in the euro zone.

2. Largest Nations in Euro zone are Weak

Euro zone 4Q 2011 GDP
Source: Eurostat, Bloomberg

Out of all the major euro zone members, only France exhibited growth. Germany, Spain and Italy, along with the minor states like as Cyprus, Austria, Belgium, Slovenia, Portugal, and the Netherlands, all contracted during the fourth quarter. Heck, Greece isn’t even in the chart because the final number still isn’t available!

This is a very bad sign as it is typically the stronger nations that should carry the weaker ones. If they are not able to, then who will? Slovakia can’t possibly carry the weight of euro zone on its shoulders. That’s like asking a 50-pound Justin Beiber (a very rough estimate) to carry a huge 15,000-pound elephant!

3. Wide-Spread Austerity Programs

It is not only Greece that has been undergoing budget reform, but a lot of other euro zone nations as well. In Portugal for example, the International Monetary Fund (IMF) has demanded a reduction in wages and pensions as well as an increase taxes and a slash public spending. The Irish have also hiked sales tax by 23% and decreased wages by 15%.

Austerity programs aren’t necessarily bad as they keep a government’s finances in check. However, austerity programs do cut deeply into job and wage growth. If there are no jobs and wages are low, then consumer spending will take a hit. Since consumer spending is the primary driver of growth, there is a high chance that we’ll see continued weakness in the GDP.

I think it’s pretty safe to say that the euro zone remains in a very fragile state, despite Greece being “safe” again. So before you go all bullish on the euro, you should ask yourself whether the fundamental and macroeconomic backgrounds have really changed.

Is the rally in the euro going to last? Or is it simply the work of over-eager buyers taking advantage of a temporary surge in risk appetite?

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