Will Europe rise from recession to be an economic superpower?

News Analysis: Positive signals from Euroland and a US rate rise are signs that the world market may be rebalancing - and if there is to be another crash, it must be on Wall Street
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The Independent Online
IS EUROPE about rise like the phoenix out of the ashes of the last recession and become the a global economic superpower? And is Wall Street's roaraway success about to judder to a halt and bring to an and America's "new economic paradigm"?

Or, in the more prosaic language of the people who analyse and study the subject, is the global economy finally starting to rebalance?

A positive set of European manufacturing, inflation and consumer-sentiment data and the first United States rate rise for 27 months last week were encouraging signals.

It is vital that Europe's economies - and therefore its beleaguered currency - do mount a recovery.

The United States, with its cocktail of high growth, low inflation and low unemployment, has acted as consumer of last resort since the Asian crisis started in 1997.

Although the momentum shows little sign of slowing, if there is to be another crash, it must be on Wall Street.

As Paul Volcker, the former Fed chairman is reputed to have said, the global economy depends on the US economy, which depends on Americans continuing to spend, which depends on the performance of the stock market, which depends on 50 companies - 25 of which have never made a profit.

This must be a cause for concern at the very least. Figures last week only gilded the lily. The NAPM manufacturing survey was so high it would have translated into 4.7 per cent GDP growth, while non-farm payrolls on Friday were above forecasts.

In Europe it is a very different story. A manufacturing recession has dragged down the economies of the 11 countries in the eurozone.

The industrial sector, which accounts for a third of total GDP - but two thirds of its variability - was punished by the collapse in exports to Asia.

In April it fell 0.7 per cent, led by Germany down 1.7 per cent and Italy down 2.3 per cent. The UK fell 2.4 per cent.

In April the European Central Bank, then only four months old, slashed the Euroland interest rate by 50 basis points to 2.5 per cent.

Faced with the sharp contrast between a strong US economy and the hesitant performance in Europe and the likely path for interest rates, the euro slumped.

To make matters worse last month, as the euro hit a new lifetime low against the dollar, Europe's finance ministers and central bankers started issuing contradictory statements on whether the ECB would intervene to prop up the euro, damning its credibility.

On Thursday, the day that the ECB celebrated its six month anniversary, the euro almost fell through the $1.02 mark and has depreciated 11 per cent this year.

As we start the third quarter of the year, there are promising signs.

On the public relations front, the ECB and the member states are now singing from the same hymn sheet - that the euro's fall is a cyclical problem and not a sign of structural problems or even a lack of credibility.

Manufacturing grew in June at its fastest rate since last September, according to the Euroland purchasing managers index.

Although Germany, the largest and most uncompetitive economy, actually contracted, its government has announced plans for an austere fiscal tightening.

If Finance Minister Hans Eichel succeeds in pushing through cuts of 30bn German marks (pounds 10bn), public deficit as a share of GDP could fall below 1 per cent.

"Eichel's determined enforcement of spending cuts puts new pressure on his colleagues. France and Italy seems set to follow the German example," says Robert Jukes, of Credit Suisse First Boston.

Meanwhile, French consumer spending rose 2.1 per cent in May.

Robert Prior-Wandesforde of HSBC said the fragile export and industrial sector was set to mount a strong recovery.

He said second-quarter data would show a miserable export performance but has pencilled in annual growth of up to 10 per cent for the three months to September.

"While the doom and gloom surrounding the Euroland economy has a little longer to run, we believe a strong industrial recovery will emerge in the second half of this year. It is vital not to give up all hope of recovery."

Ironically, the weakness of euro, and the loose monetary conditions that prompted it, are ideal for an export recovery.

As Willem Buiter, a member of the Bank of England's Monetary Policy Committee, put it: "The external weakness of the euro has been an unmitigated blessing for the Euroland countries.

"One would not like to think of what the core of Euroland would look like at the moment if the euro continued on the same level rather than falling 11 per cent."

JP Morgan has pencilled in a forecast of 3.1 per cent GDP growth in 2000 as the demand momentum that is picking up now feeds through to output.

"Given the powerful combination of supports now in place - low interest rates, a weak currency, rising global demand, and supportive fiscal policies - it would be surprising if euro area GDP did not reach 3 per cent in the coming quarters," said economist Bruce Kasman.

"If sustained, these movements will have meaningful effects in both boosting the euro area and slowing down the US."

Analysts said that, with a better outlook for European growth, an end could be in sight for the euro's long-term downtrend.

Michael Rottmann, currency strategist at Hypovereinsbank, said he does not expect the euro to reach parity with the dollar and sees a slight bounce over the coming week to around $1.035.

Kit Juckes, currency strategist at NatWest Global, said: "The economic news in Europe is becoming increasingly euro friendly. I suspect that the news is there to justify a pretty sharp correction if the ECB turns it around."

But it is no good Euroland achieving 2 per cent growth if America is powering ahead at almost 5 per cent - the transatlantic flow of wise money will still be one way.

People have been calling the bear market on Wall Street since late 1996 when Alan Greenspan, the chairman of the Federal Reserve, warned of the irrational exuberance. Since then it has gone up 5,000 points and on Friday hit a new all-time high.

But while Mr Greenspan is trying to gently deflate the bubble, there is still a real fear that a crash is around the corner - and that could trigger another global recession whatever happens in Europe.