Comment: Europe faces its turn for recession

America's coming up; Europe's going down. If there is a sense of deep frustration among Republicans that the US recovery is taking off just as their guy leaves the presidency, so there is increasing foreboding across Continental Europe that their recession will be deeper and more severe than anyone expected a couple of months ago.

To the question why the US recession proved worse than expected and the recovery later and more muted, the commonsense reply would be that there were serious structural imbalances in the States, in particular the debt burden, which have to be worked off. The UK economic situation is not an exact carbon copy of the US, but one could make the same reply for Britain.

Japan is at a different stage of the cycle from the Anglo-Saxon economies for it is still slowing but, since it also has a serious debt problem, it too can be expected to stage only a modest recovery once that gets under way.

Ask the same question of Continental Europe. Until a few months ago it would have seemed the wrong question, for by general consent the Continent was going to avoid outright recession altogether.

Late last year it was still being argued that it would escape the most severe effects of recession because it had avoided the excesses that the Anglo-Saxon market-driven economies had experienced in the late 1980s. Debt, both of individuals and of businesses, was proportionately lower so that the borrowing capacity of both was higher. As the financial sector had avoided much of the excesses of property lending, it was better able to provide finance for the expansion.

That, at least, was the conventional wisdom. Not any more. The forecasts, as in the case of the US, UK and Japan, are taking a while to catch up with reality, but the latest predictions are signalling recession this year for Germany, Italy and Spain and 1 per cent or less growth for France, the Netherlands and Belgium.

OUTPUT DOWN

Every day that passes reveals some further bad news. Yesterday it was that French industrial production fell 4.5 per cent in November, with manufacturing output down 2.1 per cent after an October decline of 1.8 per cent. There will be more bad news on the way.

What has changed? Two things - the level of real interest rates and the growing realisation that Germany's economic problems are far greater than had previously been thought.

Last summer not only were real interest rates across the Channel much lower than they are now, there was a general expectation of an early drop in line with falling German rates.

Now real interest rates are really very high by any standards and extraordinarily high for this stage of the economic cycle. Warburg calculates real French short- term rates at 9.5 per cent.

Even Italy, freed from the exchange rate mechanism, has real short-term rates of around 8 per cent, and while German real rates have come back from about 6.5 per cent they are still above of 5 per cent.

In contrast, real short-term rates in Britain are around 4.5 per cent - and below 4 per cent if you take underlying inflation as the measure rather than the more flattering RPI, which has been distorted by the fall in mortgage rates. Real US interest rates are 0.5 per cent, though in practice once you get down to these levels the actual amount charged to most borrowers fails to fall much.

Interest rates are an uncertain weapon, but an extremely powerful one. They have been likened to pulling a brick with a piece of elastic - nothing happens for a while, then suddenly the brick slides and may well pinch your fingers when it does so. We also know that interest rates frequently have an asymetrical effect.

They work more immediately in restricting demand when they are put up than they do in boosting demand when they are brought down. Couple with it the absence of expectation of an early fall in German real rates - money rates will come down, but so will inflation - and the restrictive effect is magnified further.

And Germany? It looks quite plausible that the German budget deficit this year, at 6-7 per cent of GDP, will be even larger than Britain's despite the fact that the German economy will be running closer to capacity than the UK's - though that may have changed by 1994.

At some stage there will have to be measures to curb the deficit, but it is difficult seeing these being put in place until the financial markets force such a policy.

LITTLE EFFECT

At the moment the markets are happy to finance the debt, as shown in the fall in 10-year bond yields from 9 per cent at the beginning of 1991 to a little over 7 per cent at the moment.

Moreover, as German interest rates fall there is no reason to suspect that they will be more speedy in stimulating the German economy than they have been in boosting the US one. If the US experience is any guide, a gradual fall in German rates that started last autumn and will continue through this year and next will not have much effect until perhaps late 1995. The other EC economies are so closely integrated with the Germans' that Germany will inevitably export its recession to its neighbours.

Given this outlook it is very difficult to see the ERM holding together, for the pressure for a change in policy, particularly in France, will be inevitable. So there will be a further ERM realignment soon. But, in the view of most people in the markets, that is old hat. More interesting is the question: what happens in economic terms after that?

In so far as people have thought about this they have assumed, correctly, that escape from the ERM is a necessary precondition for recovery. Few people have focused on the fact that a necessary precondition may not be a sufficient one. If Germany does not recover, cutting free from the mark will not help that much. Most Continental economies cannot cut free from the German economy, for it is their largest export market.

It is Britain's largest single export market, too, but relatively speaking we are less dependent on it than just about any other EC country. The UK recovery is still extremely fragile. British public finances are in a serious mess, but a year from now in purely relative terms the UK economy could look quite healthy . . . relative, that is, to most of the Continent.

Suggested Topics
Start your day with The Independent, sign up for daily news emails
News
people'Interview of the year' no letdown
Sport
Wayne Rooney
sportBut which sporting Brit beats him to top spot in Sunday Times Rich List?
News
Maxine Peake at home in front of a poster for Keeping Rosy
people
Arts and Entertainment
Boys in blue: Peter Firth and (right) Kit Harington in Spooks
filmHow well will Spooks make the leap from the small to the big screen?
ebooks
ebooksA special investigation by Andy McSmith
News
Royal fans covered with Union Jacks and royal memorabilia wait for Kate, Duchess of Cambridge to go into the Lindo wing at St Mary's Hospital to give birth to her second child in London, Friday, April 24, 2015.
peopleLive updates in the wait for Duchess of Cambridge's second child
Sport
Arsène Wenger (left) and Jose Mourinho have to be separated by the fourth official, Jon Moss, during last October’s Premier League match at Stamford Bridge
football
Arts and Entertainment
Tate Modern chief Chris Dercon, who will be leaving to run a Berlin theatre company
arts + ents
Arts and Entertainment
Tasos: 'I rarely refuse an offer to be photographed'
arts + ents
Arts and Entertainment
tv
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: Business Analyst - Financial Services - City, London

£50000 - £55000 per annum: Ashdown Group: Business Analyst - Financial Service...

SThree: Trainee Recruitment Consultant

£18000 - £23000 per annum + OTE £45K: SThree: At SThree, we like to be differe...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + competitive: SThree: Did you know? SThree is the o...

Recruitment Genius: Administrator - IFA Based

£22000 - £24000 per annum: Recruitment Genius: This is an opportunity to join ...

Day In a Page

Major medical journal Lancet under attack for 'extremist hate propaganda' over its coverage of the Israeli-Palestinian conflict

Lancet accused of 'anti-Israel hate propaganda' over coverage of Gaza conflict

Threat to free speech as publishers of renowned medical journal are accused of inciting hatred and violence
General Election 2015: Tories and Lib Dems throw their star names west to grab votes

All noisy on the Lib Dems' western front

The party has deployed its big guns in Cornwall to save its seats there. Simon Usborne heads to the heart of the battle
How Etsy became a crafty little earner: The online market has been floated for £1.2bn, but can craft and capitalism coexist?

How Etsy became a crafty little earner

The online market has been floated for £1.2bn, but can craft and capitalism coexist?
Guy Ritchie is the latest filmmaker to tackle King Arthur - one of our most versatile heroes

King Arthur is inspiring Guy Ritchie

Raluca Radulescu explains why his many permutations - from folk hero to chick-lit hunk - never cease to fascinate
Apple Watch: Will it live up to expectations for the man or woman on the street?

Apple Watch: Will it live up to expectations?

The Apple Watch has apparently sold millions even before its launch tomorrow
Don't fear the artichoke: it's a good cook's staple, with more choice than you'd think

Don't fear the artichoke

Artichokes are scary - they've got spikes and hairy bits, and British cooks tend to give them a wide berth. But they're an essential and delicious part of Italian cuisine
11 best men's socks

11 best men's socks

Make a statement with your accessories, starting from the bottom up
Paul Scholes column: Eden Hazard would be my Player of the Year – but I wonder if he has that appetite for goals of Messi or Ronaldo

Paul Scholes column

Hazard would be my Player of the Year – but I wonder if he has that appetite for goals of Messi or Ronaldo
Frank Warren: Tyson Fury will be closely watching Wladimir Klitschko... when he wins it'll be time to do a deal

Frank Warren's Ringside

Tyson Fury will be closely watching Wladimir Klitschko... when he wins it'll be time to do a deal
London Marathon 2015: Kenya's brothers in arms Wilson Kipsang and Dennis Kimetto ready to take on world

Kenya's brothers in arms take on world

Last year Wilson Kipsang had his marathon record taken off him by training partner and friend Dennis Kimetto. They talk about facing off in the London Marathon
Natalie Bennett interview: I've lost track of the last time I saw my Dad but it's not because I refuse to fly

Natalie Bennett interview: I've lost track of the last time I saw my Dad

Green leader prefers to stay clear of her 'painful' family memories but is more open about 'utterly unreasonable' personal attacks
Syria conflict: Khorasan return with a fresh influx of fighters awaiting the order to start 'shooting the birds'

Khorasan is back in Syria

America said these al-Qaeda militants were bombed out of the country last year - but Kim Sengupta hears a different story
General Election 2015: Is William Cash the man to woo Warwickshire North for Ukip?

On the campaign trail with Ukip

Is William Cash the man to woo Warwickshire North?
Four rival Robin Hood movies get Hollywood go-head - and Friar Tuck will become a superhero

Expect a rush on men's tights

Studios line up four Robin Hoods productions
Peter Kay's Car Share: BBC show is the comedian's first TV sitcom in a decade

In the driving seat: Peter Kay

Car Share is the comedian's first TV sitcom in a decade. The programme's co-creator Paul Coleman reveals the challenges of getting the show on the road