Euro area update - The euro area in the debt crisis maelstrom
Euro area UpdateThe Euro area in the debt crisis maelstromNordea Research, 29 November 2011 scaled down our growth forecast for 2013 from The failure of Euro area politicians to 1.8% in August to just 1.0% now. agree on a framework, which can quell the debt crisis, has pushed the Euro area In addition, it should be highlighted that the risk of towards a recession over the coming an even more negative outlook for 2012 has risen months. Thus, we have adjusted our significantly. Despite great expectations, the EU forecast for 2012 growth significantly summit conclusions from October 26 have utterly down to a decline of 0.2% compared to failed to quell the turmoil in financial markets. The 0.6% growth in August. Similarly, we have summit conclusions aimed to increase the firepower scaled down our growth forecast for 2013 of the European Financial Stability Facility (EFSF) from 1.8% in August to just 1.0% now. by leveraging the remaining funds 4-5 times to somewhere between EUR 1000 and 1400 bn. At the Our new macroeconomic forecast is moment, there are no signs that either of the two based on an assumption, that a workable leveraging instruments; offering first loss bond solution to quell the debt crisis is found insurance on new issues of government bonds or before the end of the year. If Euro area creating SPV’s focusing on purchasing government leaders fail to agree on such measures, bonds in secondary markets, can actually work. the risk of a far more serious recession grows dramatically. We expect a mild winter recession 5.0 5.0 % Euro Area GDP, y/y % The main channel for propagating the risk of a recession continues to be the banking 2.5 2.5 sector, but a tightening of fiscal policy will 0.0 0.0 also subtract nearly 1%-point from GDP growth in 2012 and 2013. -2.5 -2.5 Finally, the sharply deteriorating outlook -5.0 -5.0 for the Euro area points to a further easing GDP, annualized, q/q -7.5 -7.5 of monetary policy by the ECB. We now expect the next 25bp rate cut in -10.0 -10.0 December, bringing the refi-rate to the 02 03 04 05 06 07 08 09 10 11 12 13 same level seen during the great recession 2 years ago. In addition, we In this situation, many observers and market expect the ECB to offer a host of new participants point to large scale bond purchases by liquidity measures aimed at loosening the ECB as the only realistic option to quell the funding conditions for Euro area banks. crisis. This is clearly anathema to the ECBs This might well push EONIA rates to 30- governing council, as the new president Mario 35 bps, as was the case between July Draghi and several other members have argued that 2009 and July 2010. it is not the ECB’s remit to act as lender of last resort to Euro area governments.The Euro area is headed for a recession Euro leaders can avoid a deep recessionIn our latest Economic Outlook from the end of Our new macroeconomic forecast is based on anAugust we pointed to a significant risk of a mild assumption, that a workable solution to quell therecession in the Euro area. In particular we saw a debt crisis is found before the end of the year. Wecontinuation of the sovereign debt crisis as a key have previously pointed to the option of turning thetrigger for such a recession. This risk scenario is EFSF into a bank, which could refinance its bondnow rapidly becoming reality. Consequently we purchases at the ECB as a solution which mighthave adjusted our forecast for 2012 growth work. This solution has so far been flatly rejectedsignificantly down to a decline of 0.2% compared by the German government and the ECB, but weto 0.6% growth in August. Similarly, we have
still think this solution may come back in vogue Outlook for business investments is bleakwhen (if?) the current leveraging strategy for the 30 15 y/y Machinery y/y investments, r.a.EFSF fails. 20 10Levels of financial stress at record highs 10 5325 Bp Bp 325 0 0300 300275 275 -10 -5250 250 Itraxx senior -20 New orders -10225 financials, 5y bid 225 manufacturing,200 200 -30 advanced 3 months, l.a. -15175 175150 150 -40 -20 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11125 125100 100 Source: Nordea Markets and Reuters EcoWin 75 75 50 50 In spite of the supervisory requirements, we Aug Nov Feb May Nov Feb May Aug Nov Feb May Aug actually think that the completion of the 08 09 10 11 Source: Nordea Markets and Reuters Ecowin recapitalisation process in Q2 next year could be a turning point for the Euro area. Growth in businessIf Euro area leaders fail to agree on robust measures, investments and private consumption are usuallywhich can quell the debt crisis, the risk of a far dependent on the credit impulse, which we havemore serious recession grows dramatically. The defined as the second derivative of the outstandingmain channel for propagating the risk of a recession stock of credit to non-financial enterprises andcontinues to be the banking sector, where we households. As such, the fact that loans toalready see signs of financial stress which in some households and non-financial companies wouldrespects are comparable to the period immediately stop falling once the EU banks have met the newafter the collapse of Lehman Brothers. This could capital requirements could spur new growth privateeasily trigger a far more dramatic decline in consumption and investments.inventories and business fixed investment than weexpect in our baseline scenario. The credit impulse is key to turns in the cycle 5 % y/y BN EUR 200 Euro area 4 150Credit crisis likely to weigh on investments Real GDP, l.a. 3 100A key factor behind our significant downgrade of 2 50the economic outlook is a substantial downwards 1 0adjustment of fixed investments. This is largely 0 -50based on the fact that the funding crisis for several -1 -100 -2Euro area banks is likely to lead to a further -3 -150tightening of credit conditions for non-financial Credit impulse, r.a. -4 -200companies. This credit tightening could be further -5 -250aggravated by the new requirement for the largest -6 -300 99 00 01 02 03 04 05 06 07 08 09 10 11EU banks to bring their Core Tier1 capital ratios to Source: Nordea Markets and Reuters Ecowin9% by the end of June 2012, well ahead of the 2018 Note: The credit impulse is defined as the annual change in thedeadline otherwise envisaged in Basel III. quarterly nominal change in the outstanding stock of loans to households and non-financial companies.In the conclusions from the EU summit on October26, it was specified that banks should seek to raise Fiscal tightening across the board in 2012the capital themselves and only in the case where Turning to fiscal policy, nearly all the budgets forthis could not be achieved should member states 2012, currently being finalized in Euro areastep in with capital. This process creates a member states, point to a further tightening of fiscalsignificant risk that banks will seek to meet the policy. The pressure in financial markets is rapidlycapital requirements by shedding assets, as the low forcing Euro area governments including Franceequity valuations makes it quite unattractive for and Italy to accelerate plans for fiscal consolidation.banks to raise the necessary funds in capital In particular Italy is slated to undertake amarkets. Consequently, the EU summit conclusions substantial tightening of fiscal policy next year, ascalled for national supervisory agencies to oversee it has pledged to bring public budgets back tothat the capital requirement was not achieved balance already in 2013 even though the Italianthrough deleveraging. economy is already headed for a deep recession.
Fiscal tightening to weigh on growth in 2012 Modest depreciation of effective exchange rateChange in cyclically adjusted primary balance EER-impact for 2012 Share of Euro area GDP 2011E 2012E 2013E Baseline Risk scenarioGermany 27.0% -0.7 -0.8 -0.5 %-pointsFrance 21.0% -1.3 -1.5 -1.5 Sweden 0.1 0.1Italy 17.0% -0.9 -2.6 -1.3 Switzerland -0.1 -0.1Spain 12.0% -3.4 -1.5 -1.3 China -0.9 -2.2Belgium 3.8% -0.4 -0.5 -0.9Netherlands 6.4% -1.6 -1.2 -0.8 Japan -1.0 -2.9Austria 3.1% -0.6 -0.6 -0.3 United Kingdom 0.2 -1.9Ireland 1.5% -2.6 -1.9 -2.3 United States -2.1 -6.5Greece 2.6% -3.4 -2.4 -2.0 Sum -3.7 -13.4Portugal 1.9% -3.3 -1.6 -0.1 Based on the ECB’s Effective Exchange Rate (EER) weightsEuro area (weighted average) -1.3 -1.4 -1.0 and Nordea’s own calculations.Source: National Stability and Growth Programs, GermanMinistry of Finance, The EU Commission and Nordea’s own In a risk scenario, where the Euro area debt crisiscalculations. causes a significant fall in the EURUSD to 1.00Overall we estimate that this will subtract just with a corresponding depreciation of the EUR vis-above 1%-point from growth. The degree of fiscal à-vis the CNY and the JPY, the support for Eurotightening in 2013 is less certain, but with a area exports would be far larger, see table. Overall,continuation of the debt crisis the drag from fiscal this could lift the Euro area GDP level by nearlypolicy is likely to be of similar magnitude. 1%-point in 2012 rising to nearly 1.7% in 2013.Debt crisis is depressing consumers The ECB might try privatized QE 20 Balance Balance 20 Consumer sentiment The rapid deterioration in the economic outlook 10 Germany 10 France prompted the ECB to cut interest rates by 25bp to 0 0-10 Spain -10 1.25% at the beginning of November. So far we-20 -20 have expected the ECB to follow this move by-30 -30 another cut in the first quarter of 2012, possibly Italy-40 -40 already in January. With this update of our-50 Portugal -50 economic forecast for the Euro area we now expect-60 -60 the next rate cut already at the ECB meeting on Greece-70 -70 December 8.-80 -80 05 06 07 08 09 10 11 Source: Nordea Markets and Reuters EcoWin EONIA rates could return to 30-35bp range 3.0 % % 3.0Only limited help from exchange rates 2.5 The corridor between the refi-rate and 2.5The Euro area debt crisis has intensified in step the deposit rate was widened to 75bpswith a sharp slowdown in global growth. We still in May 2009. 2.0 2.0expect fairly robust growth in the BRIC countries 1.5 1.5during 2012 and 2013, and this should provide Main refi-ratesome underlying momentum for export growth. 1.0 1.0Growth in the most important export markets, the 0.5 0.5UK and the US is likely to remain very subdued in2012, however, see our US Update: No recession ECBs deposit rate 0.0 0.0 Jan Apr Jul Oct Jan Apr Jul Oct Jan Apr Jul Octbut slower growth. 09 10 11 Source: Nordea Markets and Reuters EcowinEven though demand growth will be fairly modestin the Euro area’s key export markets, Euro areaexports will also be lent a helping hand from a In addition to a December rate cut, we also expectdepreciation of the EUR vis-à-vis the USD and the the ECB to offer a new range of liquidity measures.CNY. In our baseline scenario we only expect the We find it most obvious that the ECB willeffective exchange rate of the EUR to depreciate by announce additional LTRO’s at the Decemberjust under 4%-points in 2012 compared to 2011. meeting. In particular we have taken note ofBased on standard multipliers this modest rumours, that the ECB should be contemplatingdepreciation should only lift the Euro area GDP LTRO’s with maturities of 2-3 years an alternativelevel by 0.3%-points in 2012 rising to 0.5% in 2013. to government guarantees on bank funding, which
are currently not very useful in the member states explained by the fact that the 12-month LTRO waslanguishing under the sovereign debt crisis. Such a offered with interest rates indexed to the average ofpolicy would thus aim to prevent a further the refi-rate over the maturity of the operation. Iftightening of credit conditions, and it might also be instead the ECB returned to letting the interest rateattractive for Euro area banks seeking to fund their be fixed at 1.00% on the forthcoming 13-monthholdings of short term bonds. LTRO, we might see much higher liquidity withdrawals. In turn this would probably pushWhether such operations will be successful will EONIA rates down to 30-35 bps, as it was the caseprobably depend on the terms offered under such between July 2009 and July 2010.operations. As an example, the new 12 month LongTerm Refinancing Operation (LTRO), launched on Anders Matzen, Chief AnalystOctober 27 only attracted bids of EUR 56.9 bn, far email@example.com + 45 33 33 33 18below the levels seen at the 12-month LTRO’soffered in 2009 even though money markets arecurrently under severe pressure. This might be Euro area: Macroeconomic indicators (% annual real changes unless otherwise noted) 2008 (EURbn) 2009 2010 2011E 2012E 2013EPrivate consumption 5,169 -1.2 0.9 0.4 0.2 0.9Government consumption 1,901 2.6 0.4 0.4 0.0 0.0Fixed investments 1,981 -11.9 -0.9 2.4 -1.0 1.6Stockbuilding* 62 -0.9 0.9 0.5 -0.2 -0.2Exports 3,877 -12.8 10.1 5.1 0.5 3.5Imports 3,788 -11.6 9.2 4.5 0.2 3.1Net exports* 89 -0.7 0.5 0.3 0.1 0.2GDP -4.2 1.8 1.6 -0.2 1.0Nominal GDP, EUR bn 9,243 8,938 9,168 9,445 9,580 9,834Unemployment rate, % 9.7 10.1 10.0 10.5 10.5Industrial production, % y/y -3.5 4.7 2.0 -1.0 1.5Consumer prices, % y/y 0.3 1.6 2.7 1.8 1.6 - core inflation** 1.3 0.9 1.6 1.6 1.2Hourly earnings, % y/y 1.4 1.5 1.6 2.1 1.6Current account, bn EUR -27.9 -45.7 -55.0 -50.0 -50.0Current account, % of GDP -0.3 -0.5 -0.6 -0.5 -0.5General government budget balance, % of GDP -6.3 -6.2 -4.1 -3.5 -2.7General government gross debt, % of GDP 79.1 84.7 86.3 88.6 89.0*Growth contribution as % of GDP.Nordea Markets is the name of the Markets departments of Nordea Bank Norge ASA, Nordea Bank AB (publ), Nordea Bank Finland Plc and Nordea Bank Danmark A/S.The information provided herein is intended for background information only and for the sole use of the intended recipient. The views and other information provided herein are thecurrent views of Nordea Markets as of the date of this document and are subject to change without notice. This notice is not an exhaustive description of the described product or therisks related to it, and it should not be relied on as such, nor is it a substitute for the judgement of the recipient.The information provided herein is not intended to constitute and does not constitute investment advice nor is the information intended as an offer or solicitation for the purchase orsale of any financial instrument. The information contained herein has no regard to the specific investment objectives, the financial situation or particular needs of any particularrecipient. Relevant and specific professional advice should always be obtained before making any investment or credit decision. It is important to note that past performance is notindicative of future results. Nordea Markets is not and does not purport to be an adviser as to legal, taxation, accounting or regulatory matters in any jurisdiction.This document may not be reproduced, distributed or published for any purpose without the prior written consent from Nordea Markets.