IHS Global Insight Perspective | |
Significance | The 1.5% quarter-on-quarter contraction in the fourth quarter of 2008 marked a substantial deepening and extension of the Eurozone recession. |
Implications | The heightened global financial crisis since September 2008 has increasingly fed through to hit already struggling Eurozone economies. |
Outlook | In its February forecast, IHS Global Insight projects Eurozone GDP to contract throughout 2009, with the decline being particularly sharp in the first half of the year; recovery is then projected to develop relatively gradually in 2010. As a result, we forecast Eurozone GDP to contract by 2.3% in 2009, before rising by just 0.1% in 2010. Furthermore, there are very serious downside risks to these forecasts. |
Eurozone GDP contracted by 1.5% quarter-on-quarter (q/q) and 1.2% year-on-year (y/y) in the fourth quarter of 2008, according to a "flash" estimate from Eurostat. This marked a substantial deepening of the Eurozone recession as GDP had previously declined by 0.2% 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 (including a very mild winter, which substantially lifted construction investment). Overall, Eurozone GDP growth fell back sharply to just 0.7% in 2008 from 2.6% 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 1.8% q/q and 2.6% y/y, following declines of 0.6% q/q in both the third and second quarters. However, although French GDP plummeted by 1.2% q/q in the fourth quarter of 2008 and was down by 1.0% 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 by 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 0.9% q/q in the fourth quarter, while previously reported flat q/q GDP in both the third and second quarters was revised downwards to show respective declines of 0.3% q/q and 0.1% q/q. Dutch GDP was down by 0.6% y/y in the fourth quarter. Portugal was another economy moving into recession, as GDP contracted by 2.0% q/q and 2.1% y/y in the fourth quarter, following a decline of 0.1% q/q in the third quarter.
Elsewhere, Belgium was in recession in all but name as GDP contracted by 1.3% q/q and 0.5% y/y in the fourth quarter of 2008, following growth of just 0.1% q/q in the third quarter. Meanwhile, 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 0.5%. Among the other Eurozone countries that have so far released their fourth-quarter 2008 GDP data, Greek growth moderated to 0.3% q/q and 2.6% y/y from 0.5% q/q and 2.9% 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 3.0% from 3.5%. Slovakia, which joined the Eurozone in January, saw annual GDP growth retreat sharply to 2.7% in the fourth quarter of 2008 from 6.6% in the third and 9.3% in the first. The fourth-quarter 2008 GDP data for other Eurozone countries are yet to be released.
Sharply Negative Investment and Net Trade Depress Q4 GDP
Eurostat is yet to release a component breakdown of Eurozone GDP in the fourth quarter. Nevertheless, evidence from Germany and France reveals that sharply contracting business investment and markedly negative net trade were key factors driving GDP downwards. Investment was clearly pared back substantially as businesses faced slumping demand, weakening capacity utilisation, very tight credit conditions, and deteriorating profitability, while Eurozone exports were dragged down by sharply weakening global economic activity and the lagged impact of the persistently strong euro.
In addition, it is highly likely that Eurozone consumer spending contracted in the fourth quarter given that retail sales volumes fell by 0.9% q/q. The German statistical office reported a small decline in household expenditure in the fourth quarter, although French consumer spending rose by 0.5% q/q. Meanwhile, evidence on the overall role of stocks in Eurozone GDP in the fourth quarter of 2008 is mixed; they dragged French GDP down substantially, but rose markedly in Germany.
Outlook and Implications
The latest data and survey evidence for the Eurozone remain largely dire across the board and point to ongoing marked contraction, although the rate of decline may have eased to some extent from the very sharp decline seen in the fourth quarter of 2008. Eurozone consumer and business confidence stood at a record 24-year low combined in January, thereby undermining prospects for investment, employment, and consumer spending. Retail sales are generally soft, manufacturing is struggling hugely, and survey evidence points to service-sector activity contracting in January at the second-deepest rate (after December) in at least 10 years. Meanwhile, exports are faltering markedly.
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 hitting foreign demand for Eurozone goods and services.
These factors are more than outweighing the help to Eurozone economic activity coming from sharply reduced commodity prices, a significant retreat in the euro from its July 2008 peak of 1 euro:US$1.60 (it is currently trading around 1 euro:US$1.30), increasing fiscal stimulus across the region, and very low interest rates (the European Central Bank has cut its key interest rate from 4.25% to 2.00% since October and further reductions are anticipated).
Consequently, in our February forecast, we project that Eurozone GDP will contract by 2.3% in 2009. Eurozone GDP is seen contracting throughout 2009, although the rate of decline should ease appreciably in the second half. All of the major Eurozone economies are forecast to endure serious GDP declines in 2009: Germany (2.8%), France (1.9%), Italy (2.7%), and Spain (2.8%).
Modest Eurozone recovery is forecast to develop throughout 2010, helped by the substantial fiscal and monetary stimulus measures now increasingly being enacted, improving global economic activity, and an anticipated easing of credit conditions. Even so, Eurozone GDP is seen edging up just 0.1% overall in 2010, with the German economy flat and France growing by 0.3%. Meanwhile, further contraction is foreseen in Spain (0.6%) and Italy (0.3%). There are clearly serious downside risks to these growth forecasts.
Data Reinforce Expectations of Another Interest-Rate Cut in March
The record contraction in Eurozone GDP in the fourth quarter of 2008 heightens pressure on the European Central Bank (ECB) to deliver the interest-rate cut that it has hinted is likely at its 5 March meeting. Indeed, even before the awful GDP data, a number of ECB policy-makers had indicated in recent days that the bank has scope to cut rates further. We expect the ECB to deliver a 50-basis-point reduction, taking its key interest rate down from 2.00% to a record low of 1.50%. Further ahead, we believe that the ECB will bring interest rates down to as low as 1.00% in the second quarter as the Eurozone economy continues to struggle markedly and inflation falls back significantly further. Interest rates are then seen staying at 1.00% throughout the rest of 2009.