Hit for six: Why Europe is still stumbling

The eurozone’s nasty recession, or is that a depression, was confirmed with news that GDP fell 0.2 per cent in the March quarter versus market expectations for a fall of 0.1 per cent. Over the past year, GDP has fallen 1 per cent.

GDP in the eurozone has been declining for what is a staggering six straight quarters, which is an ugly economic scenario that ensures the slow but very steady decline of Europe as an economic power continues. Early trends for the second quarter suggest GDP will be lucky to be zero, such is the malaise confronting the eurozone.

In reaction to the disappointing first quarter GDP result, private sector forecasters have revised down their forecasts for eurozone GDP growth in 2013 as a whole to around -1 per cent.

Within the disappointing news for the eurozone, Germany managed to record GDP growth of 0.1 per cent which followed a downwardly revised fall of 0.7 per cent in GDP in the prior quarter. A hardly impressive performance from the so-called ‘strong man’ of Europe. In France, the slow but very steady decline continued with GDP falling 0.2 per cent.

Worse still was the 0.5 per cent fall in GDP in Italy which means that the Italian economy has now been falling for a record seven straight quarters. However dreadful this economic performance in Italy is, it compares with 17 consecutive quarters of falling GDP in Greece, which on all macroeconomic measures is entrenched in depression.

The weakness in GDP fits with the earlier news on the labour market which showed the unemployment rate in the eurozone at a record high of 12.1 per cent.

The policy solution to Europe’s woes are increasingly turning to a pause in the fiscal austerity agenda that in recent years has seen an ongoing decline in government demand as a time when there has been severe weakness in the private sector. This pro-cyclical fiscal policy is obviously grinding the eurozone into what increasingly looks like a perpetual recession. Extensions for the speed at which individual governments are required to reduce their budget deficits and start to reduce the debt to GDP ratios have already been agreed, but other fiscal measures may need to be considered.

While the resistance to outright fiscal stimulus remains strong, particularly from Germany, further news of weak GDP growth will no doubt spark such calls. And given how chronically weak the economic data continues to be, the case for some growth enhancing lift in government demand should be considered.

Before then, the European Central Bank may need to not only tweak interest rates down to 0.25 per cent from the current 0.5 per cent setting, but it may need to get ready to act on Mario Draghi’s idea of setting negative interest rates. This was flagged earlier this month (Europe wakes up and smells the depression, May 3) after the ECB trimmed interest rates to 0.5 per cent. While negative interest rates would be a radical plan, again resisted by the hawks from Germany, it would encourage the banks to lend to the household and corporate sectors which in the process would help kick-start growth.

Not only does the ECB need to look to interest rate cuts, but the case for delivering quantitative easing is overwhelming, even though member countries of the eurozone have been reluctant to take up the ECB’s offer to buy and hold bonds.

The US Federal Reserve has embarked on QE and has had success underpinning economic and jobs growth.

So too has the Bank of England which overnight flagged an upward revision to its forecasts for UK economic growth. Outgoing BoE Governor, Mervyn King was clearly relieved when he said, “Today’s projections are for growth to be a little stronger and for inflation to be a little weaker than we expected three months ago.”

Tellingly King added, “That’s the first time I’ve been able to say that since before he crisis… recovery is in sight.”

Quite clearly, the economic outperformance of the US and UK relative to the eurozone is a lesson for the ECB and other policy makers – policy stimulus works even if it takes some time for it to get traction.

It is to be hoped the ECB learns from the actions of the Fed and BoE and delivers some additional policy stimulus in the not too distant future.