IHS Global Insight Perspective | |
Significance | The 1.6% quarter-on-quarter contraction in fourth-quarter GDP marked a substantial deepening and extension of the Eurozone recession. |
Implications | The heightened global financial crisis that followed the collapse of U.S. investment bank Lehman Brothers in September 2008 has increasingly fed through to hit already markedly struggling Eurozone economies. |
Outlook | In its March forecast, IHS Global Insight projected Eurozone GDP to contract by 3.0% in 2009 and then to edge downwards by a further 0.2% in 2010. There are very serious downside risks to these projections, and we are in the process of lowering them significantly further in our April forecast round. Indeed, the decline in Eurozone GDP this year now looks like being around 4.0%, given clear further very sharp contraction in the first quarter. |
Eurostat has revised the contraction in Eurozone GDP during the fourth quarter of 2008 to 1.6% quarter-on-quarter (q/q) and 1.5% year-on-year (y/y) from the previous estimates of 1.5% q/q and 1.3% y/y. This marks a substantial deepening of the Eurozone recession, as GDP had previously declined by 0.3% q/q in both the third and second quarters. The contraction in Eurozone GDP in the second quarter of 2008 was partly a correction following inflated expansion of 0.7% q/q in the first quarter when activity had been lifted by some temporary factors (notably a very mild winter, which boosted construction investment). Overall, Eurozone GDP growth fell back sharply to just 0.7% in 2008 from 2.7% in 2007 and 3.0% in 2006.
Widespread Contraction in Q4
All of the major Eurozone economies saw sharp GDP contraction in the fourth quarter of 2008. In particular, German GDP plunged by 2.1% q/q and 1.6% y/y. This was the deepest q/q contraction since German reunification in 1990 and followed GDP declines of 0.5% q/q in both the third and second quarters. In contrast, the German economy had expanded by 1.5% q/q in the first quarter of 2008, when it was boosted by very strong construction investment. The Italian recession also deepened substantially in the fourth quarter as GDP contracted by 1.9% q/q and 2.9% y/y, following declines of 0.7% q/q in the third quarter and 0.6% q/q in the second. However, although French GDP plummeted by 1.1% q/q in the fourth quarter of 2008 and was down by 0.9% y/y, this did not put the economy technically into recession (defined as two successive quarters of negative q/q GDP). This is because French GDP had previously edged up by 0.1% q/q in the third quarter after contracting by 0.3% q/q in the second quarter.
Meanwhile, Spanish GDP contracted 1.0% q/q and 0.7% y/y in the fourth quarter, having fallen 0.3% q/q in the third quarter, as the slumping construction sector and housing market weighed down ever more heavily on the economy in conjunction with the financial crisis. This put Spain into recession for the first time since 1993. In addition, the Dutch economy is now officially in recession as GDP contracted by 1.0% q/q in the fourth quarter following declines of 0.3% q/q in the third quarter and 0.1% q/q in the second. Dutch GDP was down by 0.6% y/y in the fourth quarter. Portugal was another economy moving into recession, as GDP contracted by 1.6% q/q and 1.8% y/y in the fourth quarter, following a decline of 0.2% q/q in the third quarter. Finland also entered recession as GDP contraction widened from 0.3% q/q in the third quarter to 1.3% q/q in the fourth quarter. Finnish GDP was down 1.8% y/y. A particularly sharp contraction in the fourth quarter occurred in Ireland, where GDP plunged 7.1% q/q and 7.4% y/y.
Elsewhere, Belgium was in recession in all but name as GDP plunged by 1.7% q/q and 0.8% y/y in the fourth quarter of 2008, following growth of just 0.1% q/q in the third quarter. In addition, Austrian GDP fell by 0.2% q/q in the fourth quarter, having been only flat q/q in the third quarter, thereby limiting y/y growth to 0.6%. Among the other Eurozone countries, Greek growth moderated to 0.3% q/q and 2.4% y/y from 0.4% q/q and 2.7% y/y in the third quarter. GDP in Cyprus expanded by 0.6% q/q in the fourth quarter, as it had done in the third quarter, but y/y growth slowed to 2.9% from 3.5%. Meanwhile, GDP fell by 0.9% y/y in Slovenia during the fourth quarter, having been 3.7% y/y higher in the third quarter and up 5.0% y/y in the first quarter. Completing the sorry picture, Slovakia, which joined the Eurozone in January 2009, saw annual GDP growth retreat sharply to 2.5% in the fourth quarter of 2008 from 6.6% in the third and 9.3% in the first.
Consumer Spending, Investment, Exports, and Imports All Contract
The breakdown of Eurozone GDP in the fourth quarter of 2008 shows widespread weakness, with investment and exports nose-diving. Consumer spending fell by 0.3% q/q and 0.5% y/y, having edged up by 0.1% q/q in the third quarter and fallen by 0.3% q/q in the second. This indicated that rising unemployment, tightening credit conditions, and deepening concerns over the economic situation, personal finances, and jobs outweighed the benefits of retreating inflation and lower interest rates. Earlier in 2008, Eurozone consumer spending had been held back markedly by the squeeze on purchasing power coming from high energy and food prices.
Meanwhile, gross fixed capital formation plunged by 4.0% q/q and 5.0% y/y in the fourth quarter of 2008 as businesses faced slumping demand, weakening capacity utilisation, very tight credit conditions and deteriorating profitability. Construction investment has also clearly weakened sharply, particularly in countries such as Spain and Ireland where the housing markets are slumping. This followed declines in Eurozone gross fixed capital formation of 0.7% q/q in the third quarter of 2008 and 1.3% q/q in the second. In contrast, investment had risen by 1.0% in the first quarter of 2008 (although it was inflated by a mild winter, which lifted construction investment) and by 4.4% overall in 2007. Meanwhile, government spending rose by 0.4% q/q across the Eurozone in the fourth quarter of 2008, after rising by 0.6% q/q in the third quarter and by 0.9% q/q in the second. It was up by 2.3% y/y.
The fourth-quarter q/q fall in Eurozone GDP would have been significantly deeper but for a build-up of inventories, which added 0.3 percentage point. This matched the positive contribution seen in the third quarter. However, this build-up of inventories will weigh down on growth prospects in the near term.
Net trade was sharply negative in the fourth quarter of 2008, cutting 0.9 percentage point off q/q Eurozone GDP as exports fell even more substantially than imports. Exports plunged by 6.7% q/q and 5.8% y/y in the fourth quarter, having previously fallen by 0.2% q/q in both the third and second quarters. Eurozone exports were clearly dragged down by sharply weakening global economic activity and the lagged impact of the persistently strong euro (which hit a lifetime high of 1 euro:US$1.604 in July). Meanwhile, Eurozone imports fell by 4.7% q/q and 2.9% y/y in the fourth quarter, reflecting substantially weakened domestic demand. Imports had previously risen by 1.3% q/q in the third quarter after dropping 0.5% q/q in the second.
Outlook and Implications
The latest data and survey evidence for the Eurozone remain largely dire across the board and point to ongoing very sharp contraction. Eurozone consumer and business confidence stood at a record 24-year low combined in March, thereby undermining prospects for investment, employment, and consumer spending. Retail sales are generally soft, manufacturing is struggling hugely, and survey evidence suggests that service-sector activity contracted in March at the second-deepest rate (after February) in at least 10 years. Meanwhile, exports are deteriorating substantially.
Heightened financial sector turmoil (a number of European banks have had to be rescued or helped by the authorities), very tight credit conditions, and sharply lower equity prices are hitting economic activity hard across the Eurozone. Labour markets are now weakening markedly across the region, thereby countering the boost to purchasing power coming from sharply moderating inflation. Meanwhile, significant corrections in overvalued housing markets in Spain and Ireland are hitting the rest of the economy hard, and this may well happen to a lesser extent in some other countries, possibly including France and the Netherlands. Finally, markedly weakening global growth is sharply undermining foreign demand for Eurozone goods and services. This is hitting Germany particularly hard.
These factors are more than outweighing the help to Eurozone economic activity coming from sharply lower oil and commodity prices, a significant retreat in the euro from its July 2008 peak of 1 euro:US$1.60 (it has primarily traded in a range of 1 euro:US$1.25-1.35 so far in 2009), significant fiscal stimulus measures across the region, and lower interest rates (the European Central Bank has cut its key interest rate from 4.25% to 1.25% since last October).
Consequently, in our March forecast, we projected that Eurozone GDP would contract by 3.0% in 2009. Eurozone GDP was seen contracting throughout 2009, although the rate of decline was expected to ease appreciably in the second half after a particularly torrid first half. All of the major Eurozone economies were forecast to endure serious GDP declines in 2009: Germany (3.3%), France (2.5%), Italy (3.2%), Spain (3.1%), and the Netherlands (3.1%). Modest Eurozone recovery was forecast to develop in 2010, helped by the substantial fiscal and monetary stimulus policies now increasingly being enacted, gradually improving global economic activity, and an anticipated easing of credit conditions. Even so, Eurozone GDP was seen edging down by a further 0.2% overall in 2010, with contraction in Germany (0.2%), Italy (0.5%), and Spain (0.9%). Modest growth was seen in France (0.2%) and the Netherlands (0.1%). Howevere, we are set to downgrade these projections further in our April forecasting round. Indeed, it now looks like the Eurozone will contract by around 4.0% in 2009.
Meanwhile, with the Eurozone economy currently continuing to suffer sharp contraction, and with inflationary pressures muted and still retreating, we expect the European Central Bank (ECB) to cut interest rates by a further 25 basis points from 1.25% to 1.00% at its May policy meeting and to deliver on its promise to announce significant "non-conventional" measures to support Eurozone economic activity.