Euro Area Recession Is Deepening

Euro Area growth contracted at its fastest ever rate at the end of last year, slumping unprecedented 1.5 per cent. What is behind this unexpected fall and what can be done to soften the downward spiral?

In our opinion, since this recession is different from any previous may be one of the worst once. In the first half of 2008, the downturn was triggered by a surge in the cost of credit, high oil prices and a high value of the euro. But now the slowdown is gaining momentum because of the fall in consumer sentiment and complete collapse on domestic and foreign demand. For example, weaker foreign and domestic demand have been a big drag on manufacturing and service industries, which contracted for a seventh consecutive month in December. Also, the downward correction in construction activity in some countries has gained already pace and brought down nonfinancial business investment. Moreover, the tightening of bank lending is likely to contribute to the decline in business investment. In addition, the euro area unemployment rate, which was steady so far, may surge in the next few months.

Looking ahead, the only hope for declining EU economies would be appropriate monetary and fiscal policy. But, although some stimulus packages have been already introduced, they may not bring expected effect, as they were too small or implemented too late. Also, other danger is around the corner, as global growth slows and energy costs decline amid slackening demand, concerns about deflation are increasing. From one side the drop in inflation may give more space for rates cut, but from the other an aggressive monetary policy loosening may be very dangerous for Euro Area as may lead to shift of capital to countries with higher interest rates and keep the EUR/USD under pressure.

Anna Fedec,
2/18/2009 2:23:41 PM