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Graffiti in Dublin (PETER MORRISON)
Graffiti in Dublin (PETER MORRISON)

Europe braces for more bad news Add to ...

A worse-than-expected economic downturn in Ireland and fresh signs of trouble elsewhere in Europe are raising the spectre of another recession for the region.

Ireland's economy posted a sharp retreat for the second quarter, while the euro zone's purchasing managers' index, an important barometer of economic health, fell more than expected in September. The index, which hit a seven-month low, signalled renewed weakness in both manufacturing and services across the 16-member group of countries.

"It's going to be tough for euro land to grow," Carl Weinberg, chief economist with High Frequency Economics, said in a gloomy assessment this week. He predicts a sustained economic contraction for the region. Others say growth will slow markedly, but avoid a double-dip.

Ireland, once hailed as the Celtic Tiger but now toothless, did its part to dash investor hopes of a European recovery, as its economy shrank in the second quarter by 1.2 per cent. That marks the ninth contraction in 10 quarters. The slide raised concerns about a country that had been heralded for its recently imposed fiscal austerity and promise to tackle public debt.

Shocked investors sent government bonds yields in the most-troubled economies, such as Ireland and Portugal, skyrocketing to record spreads over their German counterparts as investors weighed the possibility of what was almost unthinkable a few months ago: a double-dip recession. Ten-year Irish government bonds yielded more than 6.4 per cent late Thursday, up from about 4.5 per cent in April.

It's a surprising turn of events because European officials have long trumpeted the value of spending cuts and other austerity measures. Now some ardent defenders of those measures are left wondering whether Ireland and some of its neighbours tightened the purse strings much too soon.

Sifting through the European data, the most troubling decline occurred in the manufacturing new orders-to-inventory ratio, which fell to its lowest level since June, 2009. "This is a clear indication that the recovery is likely to lose further momentum," said Martin van Vliet, an economist with ING Bank, in a note to clients. The purchasing report "has marked slowdown written all over it."

Only a fifth-consecutive rise in the composite employment index "offers hope that the recovery does not grind to a complete halt," the bank said.

In Ireland, financial author and former banker Derek Brawn said uncertainty is driving the market's fear. Despite staggering bank bailouts, investors still "don't know what the final cost or bill to the taxpayer will be," he noted.

Investors are particularly worried about the future of Anglo Irish Bank, which just a few weeks ago was split into two to preserve the bank's good assets in an entity separate from its bad loans.

But beyond the banks, investors appear to have realized that the Irish government has few viable options left to stimulate growth. The country previously announced plans to get its deficit back to 3 per cent of annual GDP by 2014, which would meet euro zone requirements. But further spending cuts could cause further economic declines, and that would eat into the country's tax base.

"We're cutting back at the worst possible time," Mr. Brawn said. "We're looking at potentially three to four more years of more austerity, cutting massive amounts … at a time when our economy is not growing and unemployment is at record highs."

Savvy investors are not the only people who are upset. In recent weeks, broad public opinion has shifted significantly, said Constantin Gurdgiev, a finance lecturer at Trinity College in Dublin.

When the Irish government first announced spending cuts, Mr. Gurdgiev said Ireland's population demonstrated a "willingness to take the pain." But in recent weeks public opinion has turned.

The middle class is particularly upset with a rising cost of living stemming from increases in the cost of public sector products such as home energy, even though incomes are falling.

"We have very steep deflation in the real economy, and we still continue to run inflation in the public economy," Mr. Gurdgiev said.

"Ten years of work, ten years of investment, ten years of savings by people, has been wiped out," he added.

Even Germany, whose export-driven economy benefited from the steep fall of the euro, is showing signs of stress.

"Looking at the available country data, Germany is no longer bucking the trend of slowdown seen in most other euro zone economies," ING's Mr. van Vliet said in his note.

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