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EuroZone 2010: Further Expansion amid Heightened Uncertainties

Thu, Dec 31 2009, 11:40 GMT
by ecPulse.com analysis team

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The latest forecasts by the ECB, announced in December, reveal that annual real GDP growth will be between 0.1% and 1.5% in 2010, whereas the EU Commission forecasts 0.7%. The bank said the euro zone is projected to grow at a moderate pace in 2010, and the recovery process is likely to be patchy as the outlook remains subject to high uncertainty.

Eventually, the euro region will be benefiting from the inventory cycle and a rebound in exports, as well as the rippled effect of the stimulus measures which are expected to boost growth next year. The euro also weakened slightly in December which may bolster exports as it depreciates against the dollar that may strengthen next year as the U.S. economy shows strong recovery signs.

Another positive thing may be that stocks will continue creeping up in the year ahead backed by recovery signs and restored confidence; but on the other hand, any surprising fall in the economy, especially after removing emergency measures, may cause renewed panic and jitters in equity markets.

Concerning inflation, it is predicted to rise gradually within the target range set by the bank which is 2%. Rising raw material prices alongside rising food and energy prices are expected to offset the effect of rising spare capacity in the economy. Nevertheless, the ECB still sees that inflation outlook is balanced and inflation expectations are anchored.

The ECB foresees annual HICP inflation to fluctuate between 0.9% and 1.7% in 2010, while the EU Commission expects 1.10% incline. Hence, inflation is expected to surge but still will remain below the target within comfortable levels. Trichet and his Governing Council predict medium to longer term inflation to remain firmly anchored, while price developments are expected to remain subdued.

With the expected growth in the economy and ascending inflation, phasing out stimulus measures and hiking interest rates is the possible scenario in 2010. The OECD anticipates the euro zone to raise interest rate in the second half of 2010, while the stimulus will be withdrawn gradually throughout the coming year.

However, the economy might suffer the void or instability after withdrawing incentives as the economy will have to depend solely on itself in maintaining sustainable growth and inflation as well as encountering any economic problems that might take place amid its fragile state.

Although the largest economies in the euro zone emerged from recession in the third quarter, there are some small economies mired in recession and suffering from serious macroeconomic problems.

Perhaps one of the most challenging problems is the elevating unemployment which, although slightly slowed the upside race, it’s still expected to continue soaring in 2010. Some companies and financial institutions are terminating employees to cut back on expenses in order return to profitability amid the expected slow recovery and volatility in demand. The EU Commission expects the jobless rate to spike to 10.7% next year, thereby putting downside pressure on prices.

Though, eyes will be on the expected risk that might spark after the recovery or it might even hinder the recovery, which is widening budget deficits, especially in small European economies. The main focus is currently on Greece which was downgraded by Fitch and S&P to BBB+ and maybe cut by another level to BBB by March.

Credit-default swaps on Portugal’s debt climbed 6.5 basis points to 80; Hungary climbed 13 basis points to 243; Spain added 5 to 98; and Germany surged 1 to 23. Angela Merkel said that each economy has to manage its own deficit without any external help. Thus, economies will fall in the dilemma of supporting recovery through spending more and reducing taxes and on the one hand burden the pressure of reducing budget deficit via cutting spending and increasing taxes and duties in ways that can preserve growth.

Above that, the financial sector which is still suffering, may not fully recover next year as banks are facing a decline in capital and subdued lending. Therefore, banks, which may face higher funding costs after the end of the 12-month loans, probably will take longer time to recuperate from the negative consequences of the financial crisis especially as they continue to strengthen their capital and adjust their balance sheets.

In general, despite the impressive turnaround in growth, the 16-nation economy will show a slow recovery pace next year. The European Commission sees the strong recovery will be maintained in 2011, while in 2010 the economy may be vulnerable to turbulences…

• Forecast EuroZone 2010

Published on  Thu, Dec 31 2009, 11:47 GMT

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