Government austerity plans and a pullback in business spending are propelling Europe toward recession, a scenario that threatens to prolong the debt crisis, push Greece closer to default and inflict more wounds on the banks.
A widely-followed survey of purchasing managers indicated the private sector is retreating for the first time since the 17-country euro zone emerged from recession in the autumn of 2009. The slowdown in business and manufacturing activity in Germany, Europe's largest economy and the prime sponsor of the sovereign bailout programs, was acute.
The reversal is bad news for the euro zone, where growth rates were already coming down. Central bankers and finance ministers had hoped that austerity programs, anchored by spending cuts and tax increases, would be at least partly offset by stronger business, services and manufacturing activity. Some economists and strategists say the combination of austerity and a shrinking private sector virtually assures that Europe will enter its second recession in the past three years.
The poor reading on the purchasing managers index – based on a survey of more than 5,000 euro-area business executives – along with the U.S. Federal Reserve's warning Wednesday that the American economy faced "significant downside risks," slammed the European and global markets Thursday. In London, the FTSE-100 index lost 4.7 per cent. The German and French markets lost 5 per cent, paving the way for sharp declines in North American stocks. Banks and mining companies were especially hard hit as investors adjusted share prices to reflect waning growth.
"All in all, today's grim figures reinforce our suspicion that the euro zone economy as a whole might contract slightly in the second half of this year," said ING economist Martin van Vliet. "At the same time, with ongoing fiscal austerity and political leaders still way behind the curve in terms of resolving the debt crisis, we cannot dismiss the risk of a full-blown recession."
Growth forecasts are being trimmed throughout Europe. On Thursday, two days after Standard & Poor's cut Italy's credit rating, Rome said the economy should grow by only 0.7 per cent this year and 0.6 per cent next year, a big drop from its previous forecasts of 1.1 per cent and 1.3 per cent. The International Monetary Fund had reduced its European and global growth forecasts earlier in the week. In Britain, it expects growth of 1.1 per cent this year. At the start of the year, it had forecast 2-per-cent growth.
Slowing growth and the prospect of a new recession will put new stress on the efforts in the euro zone to balance budgets and halt the relentless rise in national debt loads. On Thursday, the departing chief economist of the European Central Bank, Germany's Juergen Stark, warned that high government debt threatened the very existence of the common currency. The excessive debt loads "risk undermining stability, growth and employment, as well as the sustainability" of the euro, he and his co-author economists said.
Mr. Stark resigned earlier this month from the ECB's executive board, apparently because he believed that the bank's accelerating purchases of the bonds of Italy, Greece and other debt-soaked countries blurred the line between monetary and fiscal policy. Mr. Stark and his colleagues urged governments to clamp down on deficit spending.
But the severe austerity programs that were designed to rein in deficits have hurt growth throughout the euro zone and deepened the Greek recession, triggering rising unemployment and social unrest. On Thursday, Athens was crippled by another wave of protests and strikes.
Some economists and strategists think the austerity efforts have gone too far and can only backfire when the private sector is retrenching. "We need fiscal stimulus everywhere," said Marshall Auerback, global portfolio strategist at Denver hedge fund Madison Street Partners.
The Financial Times reported Thursday night that the European Union is speeding up plans to recapitalize the 16 banks, among them German, Spanish, Greek and Italian banks, that came close to failing last summer's stress tests.
Eric Reguly