David Prosser: Europe is unravelling but the ECB still doesn't quite get it

Saturday 15 November 2008 01:00

Outlook: One by one, Europe's economies are tumbling into recession. Ireland went first, to be followed on Thursday by Germany. Yesterday, Italy joined the party – or should that be w ake? – with the effect that the eurozone as a whole also plunged into a technical recession, recording its second successive quarter of negative GDP growth. To the list you can add Spain and, of course, Britain, both of which have revealed negative third-quarter numbers and are certain to double up in the fourth quarter. Of the major European Union economies, only France reported a positive GDP figure for the three months to the end of September, but that may be a statistical oddity, buoyed as the French were by unexpectedly resilient – and almost certainly temporary – consumer spending.

What is most striking about the latest data is the speed with which the decline in the European economy has gathered pace over the past few months. It would be tempting to pin the date the slowdown became a slump to 15 September, the day the US Treasury Secretary Hank Paulson pulled the plug on Lehman Brothers, but, in fact, the latest updates from companies across the economy suggest trading had already gone seriously awry several weeks before then.

Still, as recently as the late summer, business leaders, politicians and the rest were talking up their chances of avoiding recession, or at least offering reassurances that we were in for the briefest of downturns. Was this wishful thinking that then distracted central bankers from focusing on the downside risks to inflation sooner than they did? Mervyn King, the Governor of the Bank of England, resolutely rejects the suggestion that the Monetary Policy Committee was too slow to react to the threat of recession. But the European Central Bank, which has consistently been more hawkish on inflation, despite price rises in the eurozone being more muted this year than in Britain, is arguably even more culpable. How else is one to read the fact that the base rate here is now lower than in the euro area for the first time since the single currency's launch?

Jean-Claude Trichet, the ECB's governor, still seems remarkably calm given the economic storm into which Europe is now sailing. Speaking yesterday, M. Trichet did not even address such woes, instead dwelling on his pride about the extent to which central bankers have co-ordinated their response to the credit crunch.

There are some good reasons why the ECB should feel more relaxed about the eurozone's prospects. The latest forecasts from the IMF and the OECD share the assessment that the downturn in the region next year will be less marked than in either the US or the UK. That reflects the area's exposure to housing markets and personal indebtedness where, with one or two exceptions, bubbles have not developed to anything like the extent seen in America and Britain.

Even so, the outlook is bleak. Europe ought, in theory, soon to be enjoying stronger exports given that both sterling and the euro have both tumbled against the dollar in recent months. But the theory only holds good on the assumption that someone out there in the rest of the world has money to spend importing European goods. If that is the case, perhaps they would like to start shouting about it, if only to give this part of the world some hope of a slightly less depressing Christmas.

Nor is there any prospect of Europe's banks emerging from the gloom anytime soon. Indeed, the eurozone's leading banks now seem to be playing catch-up with their counterparts elsewhere on the credit crisis, with, for example, ING of Holland and Hypo Real Estate of Germany announcing awful figures this week. Even the supposedly credit crunch-immune Spanish banks are now raising capital, with Santander in the middle of a rights issue.

No wonder eurozone leaders joining the G20 sessions in Washington today are as keen to see a global fiscal response to the recession as their opposite numbers here and in the US. But just as Mr King has fired a warning shot across the British Government's bows – any reflationary package in the pre-Budget report must be accompanied by a medium-term strategy for a more balanced budget, he says – so too will M. Trichet be demanding prudence.

The ECB will almost certainly cut interest rates further in the coming months, but its governor is in no mood to give up on his hawkish instincts. It may be some time before Britain's base rate moves above the eurozone level once more.

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