BAD news about the euro area now streams from all directions. European finance ministers flunked hard decisions on combating the debt crisis at a meeting in the Polish city of Wroclaw on September 16th and 17th and instead floated the irrelevant idea of a tax on financial transactions. Italy’s credit rating was downgraded this week by Standard & Poor’s (S&P).
In Athens, the Greek government and the troika of international institutions overseeing its austerity programme have been sparring over what else Greece needs to do to get its next, €8 billion ($11 billion) tranche of bail-out funds. Evangelos Venizelos, the Greek finance minister, complained that Greece was being “blackmailed and humiliated”, although it has little choice but to knuckle down: on September 21st, it announced measures to raise taxes, speed up public-sector lay-offs and cut some pensions. A decision on the money is expected in October.
Another current of gloom, slower-moving than the debt crisis but just as ominous, is also in full flow. The outlook for the euro-area economy is deteriorating fast, which augurs ill for attempts to wrest the finances of indebted countries under control. At best there will be a wrenching slowdown; at worst, a relapse into recession.
At the start of this year a surging recovery, led by Germany, was one reason to think that the euro zone could withstand the debt crisis. The second quarter was a disappointment, however, with GDP growth slowing from 0.8% to 0.2% in the euro area and from 1.3% to 0.1% in Germany.
New official forecasts make clear that the spring slowdown was no blip. On September 20th the IMF yanked down its predictions for euro-area growth this year and next to 1.6% and 1.1% (see chart). A few days earlier, the European Commission envisaged growth slowing to a virtual standstill, with euro-area GDP rising by 0.2% in the third quarter and just 0.1% in the fourth.
The prospects for southern Europe are dispiriting going on depressing. Unsurprisingly they are worst for Greece, whose economy is now expected to contract for four successive years. After shrinking by 2% in 2009 and 4.4% in 2010, its GDP will get 5% smaller this year and 2% smaller in 2012, according to the new IMF forecasts. In July the fund had predicted a return to modest growth in 2012.
Portugal also faces a dismal year: the fund forecasts a fall in GDP of 1.8% in 2012 after a 2.2% decline in 2011. And although Italy’s economy will at least manage to grow, it won’t feel like it. The IMF thinks that Italian GDP will rise by just 0.3% in 2012, down a full percentage point from the 1.3% it predicted in June.
The pain may be most intense in southern Europe, where the pressure for austerity is greatest, but the core economies will also be hurt. German growth will slow from 2.7% this year to 1.3% in 2012, according to the IMF. The short-term outlook could be even worse. The latest ZEW survey of analysts’ expectations for the German economy in six months’ time suggests that it is heading towards a downturn. Holger Schmieding, an economist at Berenberg Bank, thinks that a loss of confidence will push the German economy into a mild recession in late 2011 and early 2012.
A vicious feedback loop between growth, sovereign-debt concerns and banking woes is now in train. S&P cited weakening growth prospects as a crucial reason why it lowered its credit rating for Italy: a more sluggish economy will make it harder for the government to achieve its fiscal targets. The rising risk of recession will damage a fragile European banking sector, which already faces potential losses of around €200 billion from higher risk on sovereign debt, according to new IMF estimates. And if the German economy falters, that is likely to make it even trickier for Angela Merkel to convince German taxpayers that they must dip deeper into their pockets to rescue the euro. Dealing with the debt crisis just seems to get harder and harder.