The ZEW index released on Tuesday 15th confirmed that the outlook for the German economy – and as a consequence of the whole of the Euro zone economy - may further deteriorate in the next few months. The most important economic indication in the next few days will arrive from the IFO business confidence index that will be published on Thursday 24th. Our expectation is that the index will extend the downward trend started in May, in line with the indication of the Zew index.
Our estimate is that the Euro zone economy may enter in recession in Q4, with a slight contraction of 0.1/0.2% q/q and a deeper contraction in Q1 ’12 (-0.3/0.4% q/q) as signaled by major leading indicators released after the summer.
After Q1’12, the visibility of the economic outlook is very weak as the economic contraction is the result of a decline in both business and consumer confidence amid the debt crisis in peripheral countries and of the poor management of the crisis by European politicians. The US example showed that in the case the Euro zone, if authorities find an agreement to resolve – or at least to ease the debt crisis – the economic activity may recover a moderate rate of growth. Indeed, in the USA, after the debate on increase of the debt ceiling over the summer came to an end, the US economic activity rebounded in September spurring business and – in a minor way – consumer confidence: now the possibility that the US economy may fall in recession in H1 ’12 seems negligible.
For this reason now we see two scenario for the Euro zone economy:
1) The authorities find an agreement to resolve the debt crisis in the peripherals – and especially in Italy – lowering long term yields by a increase of purchase from the ECB. In this case the Euro zone recession may be mild, and the Euro zone GDP may remain unchanged in 2012 compared to 2011. This will be a good result, considering the contractive effect of the austerity measures that will be implemented in many countries. Even in this, our optimistic scenario, the GDP rate of growth will be lower than the +0.5% projected by the European Commission in the last week.
2) No agreement will be found and the tensions on the markets will remain. In this case, leading indicators may fall to 2009 levels, even if the decline of economic activity may be lower than in 2009 (-4.1%) due to the already high output gap. In this case a 1% contraction in 2012 seems very likely. Our estimate may be also be too optimistic.
Unfortunately, we agree with Paul Krugman, that in a November 9th post on the NY Times said:
I still find it hard to believe that the euro will fail; but it seems equally hard to believe that Europe will do what’s needed to avoid that failure. Irresistible force, meet immovable object — and watch the explosion.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.