Germany, France and Italy emerged from a slump at the beginning of 1997, as a stronger dollar led to a boom in exports, and domestic businesses recovered in the second half. Opinions vary on how much the Asia slowdown will cut demand for Europe's exports.
"There will be no decisive growth acceleration in 1998," said Ralf Grossmann, an economist at Caisse des Depots et Consignations. "The domestic economy won't compensate for slower export growth."
Others see bright spots. "For inflation and interest rates, the tendency is favourable," said Hans-Dieter Lauer, manager at Baden-Wuerttembergische Kapitalanlagegesellschaft. "Until the problem of Asia is sorted out, no one can raise rates."
Asian markets dropped on concern about the region's economic growth. That in turn fed concern that countries might default on their foreign borrowings. In Japan, already blighted by recession, exports suffered.
Germany, Europe's biggest economy, will grow 2.2 per cent this year and 2.6 per cent next year, the IFO predicted, adding that Asia will have only a "slight" dampening effect.
That may be optimistic. Among the major European economies, Germany exports the most to Asia. Sales to the region for example at Siemens, Germany's largest electronics company, grew an average 19 per cent in 1995 and 1996, outstripping all other areas. German banks may suffer the most. They led the world in lending to Asia in 1996. Dresdner Bank faces Asian losses of $463m, Paribas said.
France may be more vulnerable to Asian repercussions. While its exports to Asia represent a small portion of the overall economy, sales there are growing faster than anywhere else. The OECD said the French economy will expand 2.3 per cent this year and 2.9 per cent next year on the basis that "strong exports, and relatively accommodating monetary conditions should boost growth above potential in 1998-99."
Societe Generale, Paribas and other French banks are carrying loans to Asia that could end up being written off. Societe Generale stock A shares are down 20 per cent since October.
Companies like LVMH Moet-Hennessy Louis Vuitton and Hermes International, whose luxury brands are among the world's best-known, also face a threat. LVMH sells almost half of its luxury luggage and champagne goods to Asia, and its shares have fallen 42 per cent since the start of August. Hermes shares are down 30 per cent.
French companies also may find it harder to compete as Asia's currencies devalue. Shares of Usinor, Europe's second-largest steelmaker, have slid 26.1 per cent since October amid concern over plunging Asian currencies, while Yieh Loong Company, a Taiwanese steelmaker, entered the European market. Its orders are flowing into Spain and Italy at a rate of 40,000 tons per month.
In Italy, where moderate growth this year is expected to pick up speed to reach 2 per cent in 1998, lower interest rates could kindle growth. Italian rates are among the highest in the EU. With 1997 annual inflation seen below 2 per cent, the Bank of Italy will be able to lower the cost of money without fanning inflation.
Among the four biggest European economies, the UK remains the exception. Next year, as continental growth accelerates, Britain's will slow, after reaching an annual 3.7 per cent rate during the third quarter. A series of interest rate rises, tax increases and a strong pound are likely to crimp growth.