Fiscal tightening impedes eurozone recovery

The economic forecasts published last week by the European Commission for the euro area make for depressing reading.

The commission sees the eurozone economy contracting by almost 0.5% in 2012, with GDP remaining broadly flat in 2013. The unemployment rate is expected to rise further next year to around 12%.

The commission says that the ongoing correction from the financial crisis continues to weigh heavily on economic activity and employment in the eurozone. Domestic demand continues to be held back by the legacy of the crisis of 2008-09, as households, banks and governments are simultaneously reducing leverage. At the same time, the global economy has weakened over the past year, hitting exports.

The previous eurozone recession ended in mid-2009 but the subsequent recovery in activity was not only moderate but also short-lived. The economy faltered badly over the course of 2011, with GDP contracting by 0.3% in the final quarter of the year.

The economy recorded zero growth in the opening quarter of 2012 before declining again by 0.2% in quarter two, leaving output down 0.5% on year earlier levels. Germany was the only major eurozone economy to grow in the first half of 2012, with its GDP rising by a modest 0.8%.

The marked slowdown in the pace of activity in the global economy since early last year has impacted on external trade. Eurozone export growth slowed from 9.9% year-on-year in the opening quarter of 2011 to 3% by the first half of 2012.

However, it has been domestic demand which has been particularly weak, knocking 2% off GDP between mid-2011 and mid-2012.

The detailed GDP data for the second quarter showed yet another contraction in domestic demand due to further falls in fixed investment and consumer spending, as well as ongoing destocking.

A number of factors have weighed on the domestic economy, in particular the tightening of fiscal policy and the sovereign debt crisis. This crisis has damaged confidence, generated fresh concerns about the stability of the banking system and has added greatly to the tightening of both credit conditions and fiscal policy in the euro area. As a result, GDP has declined sharply in countries such as Portugal, Greece, Italy and Spain. Survey indicators suggest that the economy has contracted further during the second half of this year. The eurozone’s composite PMI, a good leading activity indicator, has continued to decline, with the index falling to 45.7 by October.

Meanwhile, another good indicator of activity, the EC’s economic sentiment index, also continues to weaken, with the October reading down to 84.5. Other data have also been weak. The key German Ifo index fell for a sixth consecutive month in October, while German industrial orders and production were both well down in the third quarter.

The annual growth rate of eurozone private sector credit moved deeper into negative territory in September, falling by 1.3% year-on-year. Meantime, the jobless rate continues to climb in the eurozone, hitting a new record high of 11.6% September. Eurozone GDP data for the third quarter are due on Thursday and are expected to show that the economy contracted by 0.2%. Eurozone GDP is likely to fall by around 0.5% in 2012 as a whole.

The eurozone is expected to see a modest improvement during 2013 as monetary easing, a weaker currency, and efforts to resolve the sovereign debt crisis help to boost activity somewhat. However, the key factors dampening growth, such as fiscal tightening and a weakened financial system, areset to continue impacting negatively on activity next year.

* Oliver Mangan chief economist AIB

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