A chink of light for the euro zone

May 1, 2009

James Saft Great Debate – James Saft is a Reuters columnist. The opinions expressed are his own –

Even without a huge fiscal boost or a hell-for-leather central bank, Europe could have a recovery, albeit a tepid one, on the cards by the end of the year.

Recent forward looking economic data is still grim, but hides within it the seeds of a rebound, as the absolutely brutal fall in manufacturing over the past six months burns itself out.

The euro zone’s economic situation is still dire and it still faces outsized risks; its banking system must deleverage and has the potential for disastrous losses while it remains unclear who in the world exactly is going to be buying enough goods to stoke a sustained recovery.

But nothing goes in the same direction forever, and absent a health or banking disaster it is reasonable to expect positive surprises from demand as the year wears on.

As those who are betting on a recovery are generally backing U.S. growth, that surprise when it comes could give a nice boost to European markets.

“There is good convincing evidence that the inventory cycle in the euro area is turning favorably,” said Aurelio Maccario, chief euro zone economist at UniCredit Group.

To come out of a recession two very important preconditions are that businesses successfully run down their stocks of goods and, at the very least, enjoy stabilization in demand.

Data from the euro zone indicates that we are moving towards such a state. The manufacturing component of Markit’s Eurozone Flash Services Purchasing Managers’ Index (PMI) was up 2.7 points to 43.6 while inventories were being run down at a record pace at 43.6. Manufacturing orders were up sharply, by 6.4 points to 37.4.

“It’s significant,” Maccario said “It’s the second consecutive increase and may represent the first signal that the trend is inverting, which is key.”

What that likely shows is that the pace of the recession is slowing, the second quarter will certainly show negative growth but also certainly be better than the first.

Other recent data was also showed improvement. The ZEW index, a measure of German analyst and investor sentiment showed that optimists on a six month view actually outnumbered pessimists for the first time since the blithe days of July 2007. A survey of French business sentiment carried out by INSEE jumped by a record amount in April.

Of course sentiment is ephemeral and could easily run into the brick wall of job losses and credit availability.


But whereas U.S. banks have made some progress in deleveraging, the same is less true for financial institutions in the euro zone, leaving open the possibility of a cut back in lending crimping growth.

In their favor, euro zone households are less indebted – owing money equal to 93 percent of GDP – than their U.S. peers, who have gorged on debt up to 130 percent of GDP. Similarly, they are less vulnerable to falls in stocks and houses because they own fewer of the first and their was generally less of a bubble in the second, a huge supporting factor for Europe as the next few years of very low growth grind on.

But Europe’s capital markets are smaller in relation to their economy than in the U.S. and their banks bigger. That mostly comes into play in the corporate sector, which has increased their debt burden in recent years and which, especially among smaller enterprises, is heavily dependent on bank borrowing.

Loans to the private sector grew at an annual rate of 3.2 percent in March, according to the ECB, down fairly sharply from February’s 4.3 percent rate. A survey by the ECB of bank lending released on Wednesday showed that banks were still tightening standards in the first quarter, but doing so less drastically than at the end of 2008.

The ECB has thus far avoided intervening directly in credit markets, preferring instead to provide financing to banks on securitizations which the banks themselves continue to own.

But ECB Executive Board member Lorenzo Bini Smaghi on Tuesday indicated that the central bank could move to buy bonds directly from banks, thus presumably freeing up money for further lending to consumers and businesses.

This makes a great deal of sense. The ECB is expected to announce “additional measures” next week which are widely expected to include some form quantitative measures such as credit purchases.

The euro zone could surprise, and pleasantly, but the longer term is still looking like a slog. U.S. demand cannot be counted on and Asian competition for what is less will only sharpen.

So it may turn out to be a rainy day, but it will seem very welcome compared to the darkness of the winter just passing.

– At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. –


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