12 February 2008

Economic Times: Europe may stay sick longer after catching US cold

Europe’s economy has caught the US’ cold, and may be sick longer. Persistent inflation and budget deficits may prevent policy makers in the 15 nations that share the euro from moving as aggressively as their US counterparts to cut interest rates and taxes. Meanwhile, Europe’s labour laws will make it harder for companies to speed a recovery in profits by reducing payrolls.

“A European downturn will take noticeably longer to run its course than the US one,” Nobel laureate Edmund Phelps, an economics professor at Columbia University in New York, said in an interview. Next year “might be a period of ‘reverse decoupling,’ with the US economy enjoying a sharp recovery and the euro-area economy stagnating,” says Dario Perkins, senior European economist for ABN Amro Holding in London. “A relatively inflexible economy and ‘sticky’ inflation” will hold Europe back, he says.

European Central Bank president Jean-Claude Trichet said twice last week that there is “unusually high uncertainty” about growth amid signs that Europe’s resistance to the US slowdown is finally wearing off.

“Risks are on the downside,” he told reporters in Tokyo on February 9 after a meeting of central bankers and finance ministers from the Group of Seven industrialised nations. The G-7 officials said the US economy may slow further, eroding global growth, and forecast no end to financial-market turmoil. “Europe cannot go unscathed from the US’s credit crisis,” says Phelps.

December retail sales in the euro region fell the most since 1995 and service industries grew in January at the slowest pace in more than four years. The European Union’s statistics office will report February 14 that the economy expanded 0.4% in the fourth quarter, half the pace of the previous three months. “Euro-zone growth is in trouble, and the risk of recession at some stage should not be underplayed,” says David Brown, chief European economist at Bear Stearns International in London. He says the region will be “very lucky” to expand 1.5% this year, which would be the weakest since 2003.

Much of what ails Europe has its origins across the Atlantic. Borrowing costs for consumers and companies jumped as BNP Paribas and other European banks ran up losses on investments tied to US mortgages. Exporters such as Heidelberg, Germany-based Heidelberger Druckmaschinen, the world’s largest maker of printing machines, blame declines in the dollar and US demand for hurting profits. Economists Jan Hatzius at Goldman Sachs and Richard Berner of Morgan Stanley say the US economy is already in a recession, and they predict that action by policy makers will ensure it is short and shallow.

Federal Reserve chairman Ben S Bernanke and his colleagues have cut interest rates five times in less than five months by a total of 2.25 percentage points. Congress last week passed an economic-stimulus package worth about $168 billion. European policy makers have been slower to administer medicine.

By: Simon Kennedy & Rich Miller

© The Economic Times