Monday, May 04, 2009


It will be twice as bad as we predicted, says Brussels

The European Union's revised forecast for its economies are even worse than the original

The European economy is in its deepest and widest recession since the second world war and recovery will not start until next year, the European commission has warned.

Unveiling revised economic forecasts, the commission said it expected the recession across Europe to be twice as bad as previously predicted and more than 11% of the workforce to join the ranks of the unemployed.

The commission accepted there have been some "positive signals" in recent weeks but nevertheless predicted that the economy of the 16-country eurozone would shrink 4% this year and another 0.1% in 2010. Only three months ago the EC was expecting a contraction of 1.9% this year and 0.4% growth in 2010.

"The European economy is in the midst of its deepest and most widespread recession in the post-war era," said the economic and monetary affairs commissioner, Joaquín Almunia.

The EU expects the British economy to contract 3.8% this year and edge up by 0.1% in 2010 – worse than chancellor Alastair Darling's budget forecast.

Almunia pointed to recent data that showed eurozone manufacturing declining at a slower pace and healthier financial markets as encouraging signs. "We are no longer in a freefall. We have the feeling the bottom is closer and closer, and thanks to fiscal stimulus and monetary stimulus ... we will avoid any new falls."

But the commission's forecasts indicate many grim months ahead, with unemployment across Europe climbing to 26m, or 11.5% – up from 7.5% last year – and inflation slowing to 0.4% and remaining well below the 2% target in 2010.

At the centre of the eurozone's problems is the vast export-driven German economy, which has been battered by the collapse in world trade. The EU is forecasting the German economy will shrink by 5.4% this year – compared with the 2.3% it had expected three months ago.

Almunia said the risk of deflation now looked "limited" and added that the European economies would have been hit even harder if EU governments had not waded in with huge fiscal stimulus packages. The new forecasts make it increasingly likely that the ECB will cut its benchmark interest rate by a further quarter per cent to 1% on Thursday. European governments could also face calls to increase stimulus spending – a move they refused before last month's G20 summit.

The commission forecasts that the eurozone budget deficit will more than triple to 6.5% of gross domestic product next year, well above the EU's upper target rate of 3%.

Ireland will have the biggest budget gap in Europe with a deficit of 12% of GDP this year rising to 15.6% in 2010. The EC predicts a peak deficit of 13.8% in the UK, compared with Darling's 12% forecast.

The Italian economy is expected to shrink more than 4%, while Spain and France, shielded to an extent by government spending, will be down 3%. However, Spanish unemployment is expected to top 20%.

The impact of the slowdown will be dramatic in eastern European countries, ending years of growth and potentially undermining their efforts to join the euro. Only one of the EU's 27 states – Cyprus – is expected to see economic growth this year. Lithuania, Latvia and Estonia are all expected to see double-digit slowdowns.

Almunia said "more needs to be done" to clean up the toxic assets on banks' balance sheets before there could be any real recovery.



Economic optimism grows as the FTSE begins to recover

As the stockmarket gains 20% in a matter of weeks, some have claimed a bull market has already begun, but can such growth be relied upon?

"The second bull market of the 21st century began in March 2009. Six months after the collapse of Lehman Brothers, stockmarket investors became confident in the stability of the banking system. Some large US banks, including Citigroup and Bank of America, still had to raise more capital to satisfy stiffer regulatory demands, but the task was achieved easily against a backdrop of improving confidence among consumers and business leaders in the US and Europe. The bankruptcy of Chrysler on the last day of April did not, to the surprise of many, affect confidence: surveys continued to point to a pick-up in activity.

"Though unemployment and the number of business failures continued to rise throughout 2009, the feared collapse in corporate earnings did not materialise. By the autumn, many large corporates were reporting stable profit margins in their first-half earnings figures, as they benefited from the disappearance of smaller competitors and the absence of wage inflation. By the end of 2009, house prices in the US and UK stopped falling, and the bull market for shares was firmly established."

Is this script absurdly cheerful? Is it merely wishful thinking based on little more than a sense that the current crop of news is marginally less awful than the stuff we have grown used to?

Maybe, but something appears to have stirred the markets. The FTSE 100 has risen 700 points, or 20%, since early March. Gains in US stockmarkets, and some European ones, have been even larger – 25% on the broad S&P 500 index, for example. But can such movements be relied upon? Remember stockmarkets bounced 20% last November and December, but the gains evaporated over January and February.

Catastrophic loss

The comparison with last year's rally is interesting. That failed because of a fresh loss of confidence in the ability of banks to absorb losses. It is harder to imagine a repeat. UK banks have been stress-tested – some have raised more capital from government and have taken out insurance against catastrophic loss – and US banks are doing the same.

What the UK experience has revealed is that recapitalisation at the hands of government doesn't have to be disastrous for a share price that is already in the gutter. If expectations of survival are low, even massive dilution for shareholders can send a price higher. Thus Lloyds Banking Group's shares have doubled in value since March.

But, you may ask, haven't the markets noticed that the International Monetary Fund is still increasing its estimate of the size of unrealised losses on duff assets in the banking system? It's a fair point, but the IMF's figures seem to have lost their power to terrify. This is for two reasons. First, the IMF – like the credit-rating agencies – so hopelessly failed to spot the banking crisis that its forecasts, even when in full gloomy mood, are now taken with a pinch of salt. Second, the IMF has little to say about a phenomenon the market can see directly: interest rates have been cut to almost zero and the banks have received a huge boost to their lending margins.

As businesses and consumers set about reducing their debts, the banks are enjoying an undeserved free lunch. Loans are being re-set at levels that are painful for the borrower but hugely beneficial to banks. This is the new bank bailout: easy profits for banks at the expense of credit-worthy borrowers. It is happening because so much lending capacity has been removed and its effect can be seen in Barclays' share price – up fivefold since January.

Can a hidden handout for the banks (even if it's big enough to remove the risk of banking meltdown) really inspire a wider rally in share prices? This is the point where the optimists' script outlined above becomes sketchy.

Recoveries in the real economy tend to require something more substantial than a handful of semi-cheerful surveys. Yes, shoppers in the UK are continuing to spend with remarkable resilience, but how long can their enthusiasm survive a near-6% drop in average weekly wages over the last year? Unemployment in the UK will peak at 3 million late next year, said the European commission yesterday, adding that the economy here will essentially stagnate in 2010.

The picture in the US is similar. Its GDP fell 6.1% in the first quarter. For the bears, it is evidence that this ­downturn will be more severe and prolonged than thought. For the bulls, the details within the GDP number contained a hint that the worst may be past: consumer spending rose 2.2%. Huge monetary stimulus appears to have succeeded in cushioning the economic pain, but, as in the UK, the question of when growth will resume is unanswered.

Probably, the most that can be said at this point is that financial Armageddon is no longer looming. That news, if it is genuine, may be worth 20% on share prices: it is an important development. But it can't create a sustained bull market. For that to happen, more good news is required – and the bankruptcy of Chrysler is a reminder that some problems in the real economy go far deeper than a banking crisis.

Bulls and bears

Crispin Odey

The London-based hedge fund manager, who made millions from shorting bank shares last year, thinks a new bull market is starting. He said in a recent report: "In a little over a month, much has changed. Stockmarkets have shot up, led by the financials and the base material sectors. The bull market will also extend from its narrow base to encompass other industries where capacity has been sufficiently reduced."

Anthony Bolton

One of the City's most respected fund managers, Bolton called the top of the bull market two years ago and now says: "I think we actually have already started a new bull market". In a recent interview he added: "When people are negative and defensive and cash positions are high, it makes me more optimistic." He predicted a new bull market would start in early 2009.

Warren Buffett

The billionaire investor Buffett's Berkshire Hathaway has just had its worst year ever, with its shares down 30% since September. Buffett had called the bottom last October - just before Lehman Brothers collapsed and markets went into a blind panic. In an interview on US television yesterday, he said the downturn had been a huge shock: "This one was a real shake; it really shook up the confidence of the American public."

Terry Smith

The outspoken chief executive of money brokers Tullett Prebon has warned that the turmoil in the financial markets could take "years, not months" to unwind. In March, he said anyone predicting green shoots of recovery was "stark raving mad" and warned the FTSE 100 had further to fall. Smith said there would be a "sucker's rally" before it resumed its downward trajectory.

Nouriel Roubini

The New York University professor who predicted the global downturn says the recent surge in equity markets is a bear market rally because there are more financial shocks coming and the US economy is very weak. He said recently. "I believe we are closer to a bottom in the stockmarket than a year ago, but this is a bear market rally. The market is way ahead of real financial data. I think people are deluding themselves."


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