THE TIMES
11.8.08
All signs indicate that euro's joyride is at an end
Rosemary Righter:
Economic view Feet firmly planted on the Maginot Line last Thursday, Jean-Claude Trichet reaffirmed the European Central Bank's settled conviction that “the fundamentals of the euro area are sound and the euro area does not suffer from major imbalances”. He admitted “downside risks” to growth, conceding that financial market turbulence might affect the real economy “more than currently anticipated”. However, he insisted that there should not be too much read into the past month's torrent of appalling eurozone economic data, breezily characterising them as a “technical correction” after strong first- quarter growth and advising sceptics to “look through the volatility in quarter-on-quarter growth rates and monthly indicators”. When the ECB raised interest rates a month ago, he added for good measure, they had “already priced in” a dip in growth in the second and third quarters, and all information available since then confirmed the wisdom of that decision. At 4.1 per cent, inflation was the enemy to beat, and it would be beaten, in a world of higher food, commodity and energy prices, only by “a change in the behaviour of companies and households”. Just take the medicine, children - though the word “recession” never crossed his lips. The quiet on the Western Front ended within 24 hours, in a trading blitzkrieg that dumped the euro for dollars. No doubt Mr Trichet would counsel against reading too much into volatile exchange movements, but it is my guess that Friday's striking about-turn - which gave the dollar its best day against important currencies since July 2002 and the euro its worst against the dollar for four years - was not a blip, but the start of a trend. That is because the ECB's see-no-evil assertion of “sound fundamentals” had the unintended effect of belatedly concentrating attention on just how unsound the eurozone's prospects - and Britain's - now look. Analysts have been so fixated by America's travails that they barely noticed how rapidly business activity and economic sentiment were collapsing across the Atlantic. The signs were there for all to read that Europe is heading into a recession from which it will struggle to recover, while America may have got away with a relatively minor economic contraction from which it may rebound sooner than expected. Take, for an overall picture of activity in the “real economy”, last month's chart from the Institute for Supply Management in the US and compare them with eurozone purchasing managers' index. On both sides of the Atlantic, business is difficult, beset by higher costs, uncertain demand, inflation worries and fear of further nasty surprises in financial markets. But in the US, the manufacturing PMI has held remarkably steady through the turbulence, with only short dips below the 50 per cent equilibrium level it is registering. The sector is adding jobs, and, at 54 per cent, export orders are healthy. More remarkably, the non-manufacturing business index, which includes rental and real estate, came in at 49.5 per cent and, after two months of contracting, the backlog of orders index rebounded to 52 per cent. Not plain sailing, but not bad for an economy that, badly shaken as it has been by the credit crunch, just chalked up its 81st month of consecutive growth. Last month's eurozone composite PMI, the weighted average of manufacturing and services output, was grimmer by far: at 47.8 per cent, it was the lowest since November 2001. Confidence indicators are falling faster than at any time since the shock caused by the attacks of September 11 in that year, dropping from 94.8 in June to 89.5 in July. Retail sales in June fell by 0.6 per cent, and by more than double that in Germany, which accounts for no less than 28 per cent of the eurozone retail market, underlining the fact that the slowdown includes domestic spending as well as foreign demand. Misery on the housing front, which is by no means confined to the profligate Anglo-Saxons, is part of the story. Housing bubbles have burst in the Irish Republic, Greece, Portugal and, most spectacularly, Spain. With an overhang of 700,000 unsold homes, exposure to Spanish mortgages may be even more unattractive than being saddled with US sub-prime paper. Business activity has dropped for seven straight months in Spain, as it has in Italy - which confirmed last week that its economy shrank in the second quarter by 0.3 per cent. So have Spanish tax revenues, and, despite fiscal stimulus measures equivalent to 1.5 per cent of GDP, retail sales are dropping like a stone and unemployment is back to double digits. But the pain in Spain would, it was argued, stay mainly in the Spanish plain. Even when the place was humming, it accounted for only 11.8 per cent of eurozone GDP. That illusion will end on Thursday, when statistics are likely to confirm that not only are Spain, Denmark, Sweden, Italy and Ireland in recessionary territory, with France in the doldrums, but Germany, the eurozone's keystone, is expected to record a fall in GDP over the last quarter of between 0.8 per cent and 1 per cent. That alone would be enough to drag the eurozone average down by 0.2 per cent - and harden sentiment against the euro. Germany's slide was unexpected and has been precipitous. Early this year its economy was running so strongly against the tide that ministers boasted how much they loved the strong euro. No longer. Factory orders have fallen for seven months in a row, from within as well as outside the eurozone, to 8.4 per cent below the levels a year ago. Consumer and business confidence have plummeted. Most ominously, inflation is 3.3 per cent - lower than the eurozone average but high enough to spook Germans, ever mindful of 1920s hyperinflation. Yet German unions are demanding inflation-beating autumn pay settlements. That increases the risk of a wage-price spiral spreading through countries such as Spain, Italy and France, where nominal wages traditionally reflect consumer prices. The ECB is between a rock and a hard place. If it defends the Maginot Line of price stability, deep and lasting recession is on the cards, yet Mr Trichet insisted last week that it could do no other. He fears that if it wavers, the ECB will be seen to have failed its first serious test. Either way, the euro's joyride is over.
TELEGRAPH Business News
11.8.08
This credit crisis is like the plague and nobody is safe yet
By Roger Bootle A year since the credit crunch burst upon an unsuspecting world, the big questions remain unanswered. Where are we now? Is it nearly over? And has understanding finally caught up with reality? The central banks' measures to return the money markets to normality by injecting massive amounts of liquidity have been at least partially successful. The spread of three-month interbank interest rates over the official policy rate - a useful indication of the willingness of banks to lend to each other - has narrowed from a peak of 1.2 percentage points to 0.8 percentage points now. Before the credit crunch struck, however, this spread was regularly in the region of 0.2 percentage points. So although the worst may now be behind us, things are far from normal. Moreover, even if the liquidity crisis may be past its worst, the housing crisis has only just begun. At the start of the credit crunch, house prices in the US had already fallen by 4pc. But over the past year they have fallen more rapidly, taking the total drop from the peak seen in 2006 to 16pc. My guess is that they still have 15pc to 20pc to fall. In the UK, incredibly, one year ago house prices were rising at the rate of 10pc per annum. One year on, the housing market is in free- fall, with prices sliding at their fastest rate on record. Indeed, they are already about 10pc below last autumn's peak. I reckon that they may have another 25pc or so to go. The eurozone has not escaped either. On some measures, house prices in Germany are now 8pc below the level seen before the credit crunch struck. And in the past year, house prices in Ireland have gone from rising at an annual rate of 6pc to falling at an annual rate of 8.5pc. In Ireland also, house prices may have another 20pc to fall. If you hear someone telling you that what has gone wrong is merely excess lending in US sub-prime, or mistakenly slow counter-actions by the central banks, both now thankfully corrected, buy them a cool, refreshing drink - and pour it over them. The current ills are the natural and inevitable result of the mammoth bubble in the housing market here and abroad. Admittedly, the extent of over-valuation of houses, and hence the extent of subsequent price falls, does not bear comparison with the mega-bubbles of the past - in dotcom shares, black tulips or South Sea stock. And at the end of this process houses, unlike dotcom shares or black tulips, will still be worth a lot. What makes this episode so special is not the size of the excessive price rise but rather the importance of the asset class caught up in the bubble. Property is simply the most important asset class there is. So with prices still falling sharply, things look far from over. Understandably, the events of the past year have had a marked impact on how well the main economies are expected to perform. Before the credit crunch struck, the consensus forecast for UK GDP growth this year was 2.2pc. It is now 1.5pc. But still the forecasting community don't get it. They downgrade their forecasts ever so carefully, inch by inch, with an ever-watchful gaze at the activities of their peers. Once we have been swamped, they will tell us that the boat is about to sink. In recent weeks, it has become clear that economic growth in the world's largest economies has all but ground to a halt. In the UK, a retrenchment in spending on the high street and the weakness of the industrial sector suggest that the economy barely grew at all in July. In the US, the latest data imply that the boost to spending from the large tax rebates is fading, suggesting that the economy may contract later this year, just as it did at the end of last year. Leaked reports indicating that German GDP fell by 1pc in Q2 suggest that the eurozone economy is dangerously close to a recession. Meanwhile, Japanese GDP is likely to have fallen in Q2. And the rest of Asia also looks likely to experience something of a slowdown. Of course, there are businesses and even individual countries that are not yet in dire straits. But a recession is like the plague: it moves from one place to another. The Black Death did not strike uniformly across the whole of Europe at exactly the same time. While it was raging in Milan, across the Alps, people in Geneva thought they were safe. Within a few months, though, they had succumbed. By the time that Geneva was gripped, in Milan things were past their worst. People in Paris still hoped they would escape. But once Geneva was recovering, Paris began to succumb. And London followed ineluctably soon afterwards. The losses from the sub-prime sector may now have been pretty fully recognised. They are unlikely to get much worse. And the policymakers are fully on top of this problem. But that doesn't mean the crisis is over. With house prices falling, banks face further writedowns that will restrict their ability to lend. This problem cannot be cured by injections of liquidity. The nature of the problem has changed from one essentially about liquidity to one about bank capital, and now also about aggregate demand. The extra capital could come from investors - although with the banks facing difficult conditions for many years ahead, it may prove tricky to get the necessary amounts from the private sector. If things get really bad it will have to be governments that stump up. Meanwhile, the deterioration in economic performance already under way will impair bank assets further and, short of massive capital injections, lead to further restriction of lending, which will squeeze the economy, leading to further asset impairment... I remain convinced that much lower interest rates will be needed to get us out of this mess - and even this will not stop the process, but merely prevent a recession from turning into a disaster. And once the situation has stabilised, radical reform of banks and the regulatory system will be needed to prevent us getting into this situation again. But that must wait. For now, survival is the name of the game. There is a glimmer of hope, though, in the shape of the recent sharp drop in oil and commodity prices. If this continues, not only will it directly bring relief to hard-pressed businesses and consumers, but it will also enable the Bank of England and the European Central Bank to cut rates further and sooner. Keep hoping. To quote someone else in another context: "This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning."
Roger Bootle is managing director of Capital Economics and economic adviser to Deloitte.
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