The euro zone's debt crisis has moved into one of its more subdued phases since late July, when the European Central Bank head, Mario Draghi, first committed to new measures to protect the euro. However, the subsidence in financial market tension has merely allowed issues surrounding the recovery of the real economy to take centre stage. The euro area economy as a whole remains in a mild recession, but of course there are stark contrasts between the severe downturns in peripheral member states and the more mild economic deceleration in the core. Fiscal consolidation is the order of the day across the euro area, so economies are likely to remain in the doldrums for another year at least.
External environment will not be particularly supportive
The Economist Intelligence Unit's global assumptions for October (which can be found at gfs.eiu.com) make clear that the global economy will not be particularly supportive of the euro area's effort to redress its economic imbalances. In an ideal world, the euro zone have other large economies growing more strongly, in order for European exports to be able to compensate for weakening domestic demand. Yet, our forecast for 2012 shows the global economy going through a weak patch in the middle of the year, with softness in the US economy coupled with a slowdown in key emerging markets. The outlook is mixed for the next 12 months too. We expect growth of just 3.1% in 2012 for the global economy at purchasing power parities (PPP), the lowest growth rate since the recovery from the 2008-09 recession started, and a mildly better 3.5% in 2013. China, increasingly an engine of global as well as Asian growth, is taking longer than expected to feel the benefits of policy stimulus. We now expect Chinese GDP growth in 2012 to fall below 8% for the first time since 1999.
That said, there have been a couple of positive developments for the global economy over the past month. First of all, the ECB's announcement of a bond-buying programme has buoyed sentiment by averting the prospect of an imminent collapse of the euro zone. Leaving aside the programme's effects on the euro area's structural problems, the ECB's new stance does allow for financial tensions to subside and for investors to move their funds out of safe havens and into more productive assets. The second positive development was the announcement by the Federal Reserve (the US central bank) that it would start a third round of quantitative easing. QE3 is significant in providing open-ended support for the US economy: the Fed says it will buy some US$40bn of mortgage-backed securities every month until the jobs outlook recovers, and has also indicated that it won't immediately turn off the monetary taps when conditions improve. The extent to which QE3 will invigorate the US economy is hotly debated, but it should boost asset prices and could thus trigger a wealth effect that raises consumer spending. It also should support the housing market, which is returning to growth after five years of contraction. Even so, the side-effects of QE3 could include higher oil and commodity prices, which will detract from disposable income.
Emerging markets have been unable to uncouple from US and European developments. Many have chosen also to apply monetary and fiscal stimulus measures, after the slowdown in early 2012 proved to be stronger than expected. China has cut interest rates twice and has loosened credit standards, in an attempt to soften the economic deceleration. India and Brazil have both cut interest rates this year. Brazil, in particular, is having a torrid year for economic growth, with GDP expected to rise by less than 2% in 2012. Stimulus programmes clearly take some time to have an effect on the real economy, and it may be the end of the year before we see a pick-up in growth in emerging markets. Even then, the acceleration is expected to be mild compared with the rebound in 2010. None of this is helpful for the euro area's economy, which would benefit from economic growth, to improve debt ratios for sovereign and private debt.
A currency depreciation would have helped the euro economy
The euro area would also tend to benefit from a weaker currency during its downturn, as this would help to boost exports, which would be priced more cheaply in foreign currencies. However, the euro has remained relatively strong for a currency in such crisis, even if it is down from its pre-crisis highs. Monetary policy has been looser in countries like the UK and the US, whereas the ECB's tighter stance has helped to support the euro's exchange rate. Moreover, although the crisis has undermined confidence in the euro as a currency area, investors have still been attracted to financial markets in individual strongly performing member states, all of which has helped to boost the currency. We expect a fairly stable euro:US dollar exchange rate in 2012-13, with only a mild strengthening of the US currency, which will hardly be enough to boost euro area GDP.
Generally then, the global economic environment is going to be less supportive of the euro zone's need for growth in the coming quarters than it was in 2010-11. Global growth faces (non-euro) downside risks from the US and China. In the US, the "fiscal cliff" looms at end-2012, and Congress has only a narrow window in which to moderate it. China is entering a tricky political transition that, if mishandled, could have implications for the economy. That notwithstanding, the principal responsibility for euro area growth lies with euro area policymakers, especially the ECB. If it wishes to boost the euro area's economy, it should loosen monetary policy further.