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November 2008
Eurozone – recession looks worse and worse Key trends •
The Eurozone is already in recession. Output fell
by 0.2% in both the June and September quarters, but things are now a lot worse. Indicators such as industrial output, retail sales and construction activity already showed a significant downturn in economic activity prior to the financial crisis in September. We have downgraded our forecasts for Eurozone activity to a drop of around 1% in output next year – the worst recession in the postwar period. That is followed by a lacklustre recovery in 2010. •
The business surveys give the most timely indicator
of economic trends and they all show a sudden and sharp deterioration in conditions through October and November. A loss of confidence in the household and business sectors has led to the postponement of discretionary spending and this is kicking back through the economy as orders and sales dry up. Unemployment is starting to climb, hitting spending power.
•
Economic policy is being loosened to limit the
impact of the downturn but it seems unable to match the erosion of activity. The European Central Bank has cut interest rates from 4¼% in July to 3¼% now and we see them cutting further to 2% by early next year. Budget policy has also turned expansionary with a fiscal stimulus package announced recently supposedly equal to 1½% of Eurozone GDP. That said, key economies like Germany are not convinced of the need to boost demand aggressively while others already face budget constraints. This fiscal response does not look very big compared to the size of the problem.
Tom Taylor Head of Economics - International (613) 8641 3475 Tom_Taylor @national.com.au
Simon Calder Economist - International (613) 8641 4034 [email protected]
Eurozone – recession looks worse and worse
Broad-based decline in activity
November 2008
Investment spending is now looking very vulnerable across the Eurozone with the housing industry starting a sharp fall
Most of the big Eurozone economies experienced falling
in activity in economies like France and Spain at a time
output in September quarter – German and Italian GDP fell
when the drivers of business investment are deteriorating.
by 0.5% in the quarter while Spanish output declined by
The share of investment and profits in GDP has been
0.2%. France was the only big economy to continue growing
particularly high, reflecting strong business profitability by
– by a modest 0.1%. The results for the December quarter
historical standards and high levels of capacity utilisation.
are likely to be a lot worse, we are expecting a decline of
We have calculated Eurozone capacity utilisation using the
around ½ percentage point followed by further falls in
business survey results for Germany, France, Spain and Italy
economic activity through the first half of next year.
and they show factory usage rates are already falling
Consumer demand has been weak for over a year with retail
sharply. The latest EU survey shows firms already planning
sales volumes actually falling and much of what strength
to cut investment and our forecast for a severe Eurozone
there has been has come from exports and investment.
recession are based on a big fall in fixed investment.
2
Eurozone – recession looks worse and worse
November 2008
We have looked at the longest running business surveys in Our forecasts are also heavily influenced by the extent to
the two biggest Eurozone economies to see how their
which business and household sentiment have softened in
November readings look in the context of past recessions.
the last two months. There has clearly been a major loss of
The IFO survey of German business shows a very sharp
confidence across almost all areas of economic activity and
decline in activity which is already back at early 1990s
this has driven an unwillingness to maintain discretionary
recessionary levels and set to go lower. The French INSEE
spending on such products as cars or durable household
business survey has been compiled since 1976 and it shows
goods, a reluctance to commit to buying houses and, in the
confidence in the general economic outlook is now the
business sector, cutbacks in orders and concern to avoid
worst ever. Harder data measures like new orders and
carrying excess inventories into a severe downturn. The
output trends have fallen to early 1990s levels and that was
outcome is that these very big falls in measures of business
France’s deepest postwar recession. Turning to consumer
confidence are also reflected in the “harder” numbers of
confidence measures, the same weakness is evident with
business conditions as lower orders, falling output,
householders fearing for their jobs, pay and prospects.
cancelled investments and staff layoffs and retrenchment.
3
Eurozone – recession looks worse and worse
ECB cutting interest rates Faced with this serious economic situation, the ECB and major Eurozone Governments have done abrupt U-turns in their economic policies. The ECB was still giving priority to combatting inflationary pressures until August and its last increase in interest rates (to 4¼%) was as recent as July. The ECB then lowered rates by 50 bps in mid-October, another 25 bps in mid-November and we expect rates to be down to 2% by early next year. That would still leave Eurozone rates well above those in the US or Japan and at their lows seen between 2003 and 2005. Given the size of the downturn facing the Eurozone economy and the prospective drop in inflation there could be some downside risk to this rate view but the ECB is a hawkish institution.
4
November 2008
As elsewhere, the impact of ECB rate cuts is limited by the wider spreads that lenders require to compensate for heightened risk. Interbank rates now carry a much wider spread over the ECB policy rate than before the onset of the financial crisis and retail rates are proving sticky downwards as Eurozone banks protect their margins. The ECB survey of bank lending shown in the chart at the foot of the page shows how banks have tightened their retail loan approval criteria across the board. Much retail loan pricing is tied to long term fixed rates, eroding the impact of falls in policy rates. Finally, although banks in many Eurozone economies face fierce political criticism over the supply of credit, many borrowers are over-geared and their credit demand is falling as they strengthen vulnerable balance sheets.
Eurozone – recession looks worse and worse
Fiscal measures to boost demand Following the November G20 meeting which called on Governments to “use fiscal measures to stimulate domestic demand” and a raft of fiscal policiy announcements elsewhere, the European Commission has announced its plan for a stimulus that amounts to €200 Billion, equal to around 1½% of GDP. The Eurozone’s budget situation has
November 2008
committed to boosting demand, already have a sizeable deficits. The European Commission has agreed to suspend the Maastricht rules limiting the size of budget deficits to 3% as these are extraordinary circumstances, but it has made it clear that it will be enforcing them again in the not too distant future. This limits the scale of what those economies with larger deficits can manage to do now.
improved in recent years, widening the scope for action.
The legacy of previous unsuccessful European attempts to use fiscal policy to cushion economic activity in the face of While the size sounds impressive, the details of the plan
downturns is overshadowing the current exercise. Having
have been left up to individual Governments and they are
spent years getting their budget into better shape, the
not all equally committed to the need for budgetary
Germans are reluctant to repeat past unfortunate episodes
measures to boost their economies. The UK led the way
where Germany was to play the role of the “locomotive” of
with its package of VAT cuts, direct tax cuts and higher
European economy. The French are hesitant to pump
spending and there were calls for the Eurozone to try a
demand into their economy using measures like VAT cuts
similar harmonised cut in VAT rates equal to 1 percentage
because they remember the ill-fated Mitterand economic
point of GDP. In the event, however, nothing so uniform has
stimulus of the early 1980s where a lot of the demand went
emerged and there is real doubt whether key Governments –
to fill the order books of German industry rather than
notably Germany – will add to the rather modest fiscal
boosting French manufacturing. Hence the preference in
measures they have already announced.
many economies for Government spending and public works – this gives a much higher “fiscal multiplier” boost to
This is particularly serious as Germany is not only the
activity in the originating country than tax cuts which leak
biggest economy in the Eurozone but it also has the best
to imports. Consequently, behind the façade of EU unity, it
budgetary position to implement a sizeable stimulus.
still looks like everyone for themselves and that limits the
Countries like France and Italy, by contrast, which are more
chances of a big fiscal package until things get really grim.
5
Macroeconomic, Industry & Markets Research Australia Alan Oster
Group Chief Economist
+(61 3) 8641 3464
Jacqui Brand
Personal Assistant
+(61 3) 8641 4179
Jeff Oughton
Head of Economics – Australia & Industry
+(61 3) 8641 3469
John Sharma
Economist – Australia
+(61 3) 8641 4304
Dean Pearson
Senior Economist – Industry & Commodities
+(61 3) 8641 3474
Gerard Burg
Economist – Industry Conditions
+(61 3) 8641 3984
Ian Gordon
Economist – Industry Conditions
+(61 3) 8641 3472
Frank Drum
Economist – Agribusiness
+(61 3) 8641 3442
Tom Taylor
Head of Economist – International
+(61 3) 8641 3475
Robert De Iure
Economist – Country Risk
+(61 3) 8641 3445
Carolyn Fraser
Economist – International
+(61 3) 8641 3694
Vacant
Economist – International
+(61 3) 8641 3848
Robert Henderson
Chief Economist Markets – Australia
+(61 2) 9237 1836
David de Garis
Senior Economist – Markets
+(61 2) 9237 1180
Spiros Papadopoulos
Senior Economist – Markets
+(61 3) 8641 0978
Tony Alexander
Chief Economist – BNZ
+(64 4) 474 6744
Stephen Toplis
Head of BNZ Market Economist
+(64 4) 474 6905
Craig Ebert
Senior Economist, Markets
+(64 4) 474 6799
Mark Walton
Market Economist
+(64 4) 474 6923
Tom Vosa
Head of Market Economics – UK
+(44 20) 7710 1573
David Tinsley
Senior Economist - Markets
+(44 20) 7710 2910
New Zealand
London
DISCLAIMER: “[While care has been taken in preparing this material,] National Australia Bank Limited (ABN 12 004 044 937) does not warrant or represent that the information, recommendations, opinions or conclusions contained in this document (“Information”) are accurate, reliable, complete or current. The Information has been prepared for dissemination to professional investors for information purposes only and any statements as to past performance do not represent future performance. The Information does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. In all cases, anyone proposing to rely on or use the Information should independently verify and check the accuracy, completeness, reliability and suitability of the Information and should obtain independent and specific advice from appropriate professionals or experts. To the extent permissible by law, the National shall not be liable for any errors, omissions, defects or misrepresentations in the Information or for any loss or damage suffered by persons who use or rely on such Information (including by reasons of negligence, negligent misstatement or otherwise). If any law prohibits the exclusion of such liability, the National limits its liability to the re-supply of the Information, provided that such limitation is permitted by law and is fair and reasonable. The National, its affiliates and employees may hold a position or act as a price maker in the financial instruments of any issuer discussed within this document or act as an underwriter, placement agent, adviser or lender to such issuer.” UK Disclaimer: So far as the law and the FSA Rules allow, National Australia Bank Limited (“the Bank”) disclaims any warranty or representation as to the accuracy or reliability of the information and statements in this document. The Bank will not be liable (whether in negligence or otherwise) for any loss or damage suffered from relying on this document. This document does not purport to contain all relevant information. Recipients should not rely on its contents but should make their own assessment and seek professional advice relevant to their circumstances. The Bank may have proprietary positions in the products described in this document. This document is for information purposes only, is not intended as an offer or solicitation nor is it the intention of the Bank to create legal relations on the basis of the information contained in it. No part of this document may be reproduced without the prior permission of the Bank. This document is intended for Investment Professionals (as such term is defined in The Financial Services and Markets Act 2000 (Financial Promotion) Order 2001) and should not be passed to any other person who would be defined as a private customer by the rules of the Financial Services Authority (“FSA”) in the UK or to any person who may not have experience of such matters. Issued by National Australia Bank Limited A.C.N. 004 044 937, 88 Wood Street, London EC2V 7QQ. Registered in England BR1924. Head Office: 500 Bourke Street, Melbourne, Victoria. Incorporated with limited liability in the state of Victoria, Australia. Regulated by the FSA in the UK. U.S DISCLAIMER: This information has been prepared by National Australia Bank or one of its affiliates or subsidiaries (collectively, “NAB”). If it is distributed in the United States, such distribution is by National Australia Capital Markets, LLC (NACM) which accepts responsibility for its contents. Any U.S. person receiving this information wishes further information or desires to effect transactions in the securities described herein should call or write to NACM, 200 Park Avenue, New York, NY 10166 (or call (877) 377-5480). The information contained herein has been obtained from, and any opinions herein are based upon sources believed to be reliable and no guarantees, representations or warranties are made as to its accuracy, completeness or suitability for any purpose. Any opinions or estimates expressed in this information is our current opinion as of the date of this report and is subject to change without notice. The principals of NACM or NAB and/or its affiliates may have a long or short position or may transact in the securities referred to herein or hold or transact derivative instruments, including options, warrants or rights with securities, or may act as a market maker in the securities discussed herein and may sell such securities to or buy from customers on a principal basis. This material is not intended as an offer or solicitation for the purchase or sale of the securities described herein or for any other action. It is intended for the information of clients only and is not for publication in the press or elsewhere.
6
Eurozone – recession looks worse and worse Key trends •
The Eurozone is already in recession. Output fell
by 0.2% in both the June and September quarters, but things are now a lot worse. Indicators such as industrial output, retail sales and construction activity already showed a significant downturn in economic activity prior to the financial crisis in September. We have downgraded our forecasts for Eurozone activity to a drop of around 1% in output next year – the worst recession in the postwar period. That is followed by a lacklustre recovery in 2010. •
The business surveys give the most timely indicator
of economic trends and they all show a sudden and sharp deterioration in conditions through October and November. A loss of confidence in the household and business sectors has led to the postponement of discretionary spending and this is kicking back through the economy as orders and sales dry up. Unemployment is starting to climb, hitting spending power.
•
Economic policy is being loosened to limit the
impact of the downturn but it seems unable to match the erosion of activity. The European Central Bank has cut interest rates from 4¼% in July to 3¼% now and we see them cutting further to 2% by early next year. Budget policy has also turned expansionary with a fiscal stimulus package announced recently supposedly equal to 1½% of Eurozone GDP. That said, key economies like Germany are not convinced of the need to boost demand aggressively while others already face budget constraints. This fiscal response does not look very big compared to the size of the problem.
Tom Taylor Head of Economics - International (613) 8641 3475 Tom_Taylor @national.com.au
Simon Calder Economist - International (613) 8641 4034 [email protected]
Eurozone – recession looks worse and worse
Broad-based decline in activity
November 2008
Investment spending is now looking very vulnerable across the Eurozone with the housing industry starting a sharp fall
Most of the big Eurozone economies experienced falling
in activity in economies like France and Spain at a time
output in September quarter – German and Italian GDP fell
when the drivers of business investment are deteriorating.
by 0.5% in the quarter while Spanish output declined by
The share of investment and profits in GDP has been
0.2%. France was the only big economy to continue growing
particularly high, reflecting strong business profitability by
– by a modest 0.1%. The results for the December quarter
historical standards and high levels of capacity utilisation.
are likely to be a lot worse, we are expecting a decline of
We have calculated Eurozone capacity utilisation using the
around ½ percentage point followed by further falls in
business survey results for Germany, France, Spain and Italy
economic activity through the first half of next year.
and they show factory usage rates are already falling
Consumer demand has been weak for over a year with retail
sharply. The latest EU survey shows firms already planning
sales volumes actually falling and much of what strength
to cut investment and our forecast for a severe Eurozone
there has been has come from exports and investment.
recession are based on a big fall in fixed investment.
2
Eurozone – recession looks worse and worse
November 2008
We have looked at the longest running business surveys in Our forecasts are also heavily influenced by the extent to
the two biggest Eurozone economies to see how their
which business and household sentiment have softened in
November readings look in the context of past recessions.
the last two months. There has clearly been a major loss of
The IFO survey of German business shows a very sharp
confidence across almost all areas of economic activity and
decline in activity which is already back at early 1990s
this has driven an unwillingness to maintain discretionary
recessionary levels and set to go lower. The French INSEE
spending on such products as cars or durable household
business survey has been compiled since 1976 and it shows
goods, a reluctance to commit to buying houses and, in the
confidence in the general economic outlook is now the
business sector, cutbacks in orders and concern to avoid
worst ever. Harder data measures like new orders and
carrying excess inventories into a severe downturn. The
output trends have fallen to early 1990s levels and that was
outcome is that these very big falls in measures of business
France’s deepest postwar recession. Turning to consumer
confidence are also reflected in the “harder” numbers of
confidence measures, the same weakness is evident with
business conditions as lower orders, falling output,
householders fearing for their jobs, pay and prospects.
cancelled investments and staff layoffs and retrenchment.
3
Eurozone – recession looks worse and worse
ECB cutting interest rates Faced with this serious economic situation, the ECB and major Eurozone Governments have done abrupt U-turns in their economic policies. The ECB was still giving priority to combatting inflationary pressures until August and its last increase in interest rates (to 4¼%) was as recent as July. The ECB then lowered rates by 50 bps in mid-October, another 25 bps in mid-November and we expect rates to be down to 2% by early next year. That would still leave Eurozone rates well above those in the US or Japan and at their lows seen between 2003 and 2005. Given the size of the downturn facing the Eurozone economy and the prospective drop in inflation there could be some downside risk to this rate view but the ECB is a hawkish institution.
4
November 2008
As elsewhere, the impact of ECB rate cuts is limited by the wider spreads that lenders require to compensate for heightened risk. Interbank rates now carry a much wider spread over the ECB policy rate than before the onset of the financial crisis and retail rates are proving sticky downwards as Eurozone banks protect their margins. The ECB survey of bank lending shown in the chart at the foot of the page shows how banks have tightened their retail loan approval criteria across the board. Much retail loan pricing is tied to long term fixed rates, eroding the impact of falls in policy rates. Finally, although banks in many Eurozone economies face fierce political criticism over the supply of credit, many borrowers are over-geared and their credit demand is falling as they strengthen vulnerable balance sheets.
Eurozone – recession looks worse and worse
Fiscal measures to boost demand Following the November G20 meeting which called on Governments to “use fiscal measures to stimulate domestic demand” and a raft of fiscal policiy announcements elsewhere, the European Commission has announced its plan for a stimulus that amounts to €200 Billion, equal to around 1½% of GDP. The Eurozone’s budget situation has
November 2008
committed to boosting demand, already have a sizeable deficits. The European Commission has agreed to suspend the Maastricht rules limiting the size of budget deficits to 3% as these are extraordinary circumstances, but it has made it clear that it will be enforcing them again in the not too distant future. This limits the scale of what those economies with larger deficits can manage to do now.
improved in recent years, widening the scope for action.
The legacy of previous unsuccessful European attempts to use fiscal policy to cushion economic activity in the face of While the size sounds impressive, the details of the plan
downturns is overshadowing the current exercise. Having
have been left up to individual Governments and they are
spent years getting their budget into better shape, the
not all equally committed to the need for budgetary
Germans are reluctant to repeat past unfortunate episodes
measures to boost their economies. The UK led the way
where Germany was to play the role of the “locomotive” of
with its package of VAT cuts, direct tax cuts and higher
European economy. The French are hesitant to pump
spending and there were calls for the Eurozone to try a
demand into their economy using measures like VAT cuts
similar harmonised cut in VAT rates equal to 1 percentage
because they remember the ill-fated Mitterand economic
point of GDP. In the event, however, nothing so uniform has
stimulus of the early 1980s where a lot of the demand went
emerged and there is real doubt whether key Governments –
to fill the order books of German industry rather than
notably Germany – will add to the rather modest fiscal
boosting French manufacturing. Hence the preference in
measures they have already announced.
many economies for Government spending and public works – this gives a much higher “fiscal multiplier” boost to
This is particularly serious as Germany is not only the
activity in the originating country than tax cuts which leak
biggest economy in the Eurozone but it also has the best
to imports. Consequently, behind the façade of EU unity, it
budgetary position to implement a sizeable stimulus.
still looks like everyone for themselves and that limits the
Countries like France and Italy, by contrast, which are more
chances of a big fiscal package until things get really grim.
5
Macroeconomic, Industry & Markets Research Australia Alan Oster
Group Chief Economist
+(61 3) 8641 3464
Jacqui Brand
Personal Assistant
+(61 3) 8641 4179
Jeff Oughton
Head of Economics – Australia & Industry
+(61 3) 8641 3469
John Sharma
Economist – Australia
+(61 3) 8641 4304
Dean Pearson
Senior Economist – Industry & Commodities
+(61 3) 8641 3474
Gerard Burg
Economist – Industry Conditions
+(61 3) 8641 3984
Ian Gordon
Economist – Industry Conditions
+(61 3) 8641 3472
Frank Drum
Economist – Agribusiness
+(61 3) 8641 3442
Tom Taylor
Head of Economist – International
+(61 3) 8641 3475
Robert De Iure
Economist – Country Risk
+(61 3) 8641 3445
Carolyn Fraser
Economist – International
+(61 3) 8641 3694
Vacant
Economist – International
+(61 3) 8641 3848
Robert Henderson
Chief Economist Markets – Australia
+(61 2) 9237 1836
David de Garis
Senior Economist – Markets
+(61 2) 9237 1180
Spiros Papadopoulos
Senior Economist – Markets
+(61 3) 8641 0978
Tony Alexander
Chief Economist – BNZ
+(64 4) 474 6744
Stephen Toplis
Head of BNZ Market Economist
+(64 4) 474 6905
Craig Ebert
Senior Economist, Markets
+(64 4) 474 6799
Mark Walton
Market Economist
+(64 4) 474 6923
Tom Vosa
Head of Market Economics – UK
+(44 20) 7710 1573
David Tinsley
Senior Economist - Markets
+(44 20) 7710 2910
New Zealand
London
DISCLAIMER: “[While care has been taken in preparing this material,] National Australia Bank Limited (ABN 12 004 044 937) does not warrant or represent that the information, recommendations, opinions or conclusions contained in this document (“Information”) are accurate, reliable, complete or current. The Information has been prepared for dissemination to professional investors for information purposes only and any statements as to past performance do not represent future performance. The Information does not purport to contain all matters relevant to any particular investment or financial instrument and all statements as to future matters are not guaranteed to be accurate. In all cases, anyone proposing to rely on or use the Information should independently verify and check the accuracy, completeness, reliability and suitability of the Information and should obtain independent and specific advice from appropriate professionals or experts. To the extent permissible by law, the National shall not be liable for any errors, omissions, defects or misrepresentations in the Information or for any loss or damage suffered by persons who use or rely on such Information (including by reasons of negligence, negligent misstatement or otherwise). If any law prohibits the exclusion of such liability, the National limits its liability to the re-supply of the Information, provided that such limitation is permitted by law and is fair and reasonable. The National, its affiliates and employees may hold a position or act as a price maker in the financial instruments of any issuer discussed within this document or act as an underwriter, placement agent, adviser or lender to such issuer.” UK Disclaimer: So far as the law and the FSA Rules allow, National Australia Bank Limited (“the Bank”) disclaims any warranty or representation as to the accuracy or reliability of the information and statements in this document. The Bank will not be liable (whether in negligence or otherwise) for any loss or damage suffered from relying on this document. This document does not purport to contain all relevant information. Recipients should not rely on its contents but should make their own assessment and seek professional advice relevant to their circumstances. The Bank may have proprietary positions in the products described in this document. This document is for information purposes only, is not intended as an offer or solicitation nor is it the intention of the Bank to create legal relations on the basis of the information contained in it. No part of this document may be reproduced without the prior permission of the Bank. This document is intended for Investment Professionals (as such term is defined in The Financial Services and Markets Act 2000 (Financial Promotion) Order 2001) and should not be passed to any other person who would be defined as a private customer by the rules of the Financial Services Authority (“FSA”) in the UK or to any person who may not have experience of such matters. Issued by National Australia Bank Limited A.C.N. 004 044 937, 88 Wood Street, London EC2V 7QQ. Registered in England BR1924. Head Office: 500 Bourke Street, Melbourne, Victoria. Incorporated with limited liability in the state of Victoria, Australia. Regulated by the FSA in the UK. U.S DISCLAIMER: This information has been prepared by National Australia Bank or one of its affiliates or subsidiaries (collectively, “NAB”). If it is distributed in the United States, such distribution is by National Australia Capital Markets, LLC (NACM) which accepts responsibility for its contents. Any U.S. person receiving this information wishes further information or desires to effect transactions in the securities described herein should call or write to NACM, 200 Park Avenue, New York, NY 10166 (or call (877) 377-5480). The information contained herein has been obtained from, and any opinions herein are based upon sources believed to be reliable and no guarantees, representations or warranties are made as to its accuracy, completeness or suitability for any purpose. Any opinions or estimates expressed in this information is our current opinion as of the date of this report and is subject to change without notice. The principals of NACM or NAB and/or its affiliates may have a long or short position or may transact in the securities referred to herein or hold or transact derivative instruments, including options, warrants or rights with securities, or may act as a market maker in the securities discussed herein and may sell such securities to or buy from customers on a principal basis. This material is not intended as an offer or solicitation for the purchase or sale of the securities described herein or for any other action. It is intended for the information of clients only and is not for publication in the press or elsewhere.
6
