S&P Warns "Prospect Of European Double Dip Looking More Likely"
Yesterday, Goldman proclaimed that their new base case outlook is one of a double dip for Germany and France, and hence all of Europe. Now, it is S&P's turn. In a just released report, S&P says that "The prospect that Europe might dip into recession again is looking more likely. The flow of news and market developments in recent weeks, such as sharply deteriorating business sentiment and a projected slowdown in the U.S., has led us to once again revise downward our projections for economic growth in 2012. This follows a number of downside revisions in our last economic outlook at the end of August. We now forecast GDP growth in the eurozone at 1.1% in 2012, compared with 1.5% in our earlier projection. For the U.K., we expect a GDP growth rate at 1.7% in 2012, slightly below our 1.8% projection in August. We still do not expect a genuine double dip to occur in the eurozone as a whole or in the U.K., but we recognize that the probability of another recession in Western Europe has continued to grow. We now estimate the probability of a new recession in Western Europe next year at about 40%. In our baseline forecast, however, we continue to anticipate sluggish and unevenly distributed growth over the coming five quarters." Next up: rating warning for France, and all EFSF bets are off?
Overall, nothing too new in the report, but the overall bearishness is surprising:
Business Surveys Fell Sharply Through The Summer
Among the several recent developments that have led us to cut our forecasts are business surveys from August and September, which point to a fresh deterioration in the business climate. This is visible not only in those economies typically most exposed to the sovereign crisis--such as Portugal, Spain, and Ireland--but also in the core countries of the eurozone and in the U.K. (see chart 1). In Germany, the widely followed IFO index pointed to deteriorating business expectations in September. This echoed the rising pessimism of investors that same month in the ZEW investor sentiment index from the Center for European Economic Research. Growing pessimism in the corporate sector is equally visible in the U.K., France, and Italy.
This declining business confidence reflects the slowdown in the manufacturing and service sectors across Europe since the beginning of the second quarter, in our view. But an additional negative factor has gradually emerged over the past three months. Financial market pressures on European banking institutions have sharply increased, as testified by the fall in bank share prices since early July. Concerns about the European banks' sovereign exposure have led investors to reduce their holdings of bank shares, in turn causing financial institutions to accelerate strengthening their balance sheets. Several major banks have recently announced that they intend to reduce the size of their balance sheets to raise their solvency ratios. We anticipate that a possible consequence of this for European corporate borrowers relying on bank lending could be more expensive financing costs. We believe this presents additional downside risks for capital spending in 2012.
The US is also not insulated:
A Forecast U.S. Slowdown Will Also Hit European Exports
Another factor behind our decision to lower our projections for the European economies again is the cut in our forecast for the U.S. economy. Continued weakness in labor markets, the persistent decline in house prices, and anemic consumer demand have caused Standard & Poor's Ratings Services U.S. economists to lower their GDP growth projections for 2012 and 2013 from 2.4% and 2.6%, respectively, last July to 1.9% and 2.2% in September (for further details see "U.S. Economic Forecast: Fishing For A Recovery," published on Sept. 14, 2011, on RatingsDirect on the Global Credit Portal). These significant revisions have important implications for Europe's foreign trade sector, in our view. The U.S. remains the No. 1 destination for EU exports (see table 1) and the second destination, after the U.K., for eurozone exports. In addition, weaker demand from the U.S. is likely to penalize emerging markets' exports, causing second-round negative effects on European trade with those markets.
Headwinds Point To Lower GDP Growth
In light of these developments, we are now further lowering our economic growth forecasts for Europe's four largest economies from our previously published predictions (for further details see "Slowing Growth In Europe Increases The Risk Of A Double Dip," published on Aug. 30, 2011, on RatingsDirect on the Global Credit Portal). Our major revisions are as follows (see also table 2):
Germany. We have revised our 2012 projections of GDP growth down to 1.5% from 2.0%, reflecting weaker demand from non-European markets. By contrast, we continue to expect relatively positive trends in consumer demand on the back of continued growth in employment and real disposable incomes. We anticipate private consumption will expand by 1.2% in 2011 and 1.5% next year.
France. We have cut our GDP growth forecast for 2012 to 1.3% from 1.7% based on a number of considerations. First, we believe that market pressures on French banks, if they persist, are likely to limit credit distribution. Second, the recent performance of French exports has been somewhat disappointing, in our view, increasing by only an estimated 4% this year--half the rate of growth of German exports. Nevertheless, our projection is still a little higher than the Consensus Economics forecast for 1.2% GDP growth for 2012 in its September edition. This is because we believe French consumers will be able to increase their spending next year by about 1.2% on the back of a lower savings rate and because construction activity should remain fairly buoyant: residential dwellings are still in insufficient supply.
Italy. We've lowered our GDP growth projection for next year to 0.5% from 0.8%. This is because we believe that fiscal measures that the government presented during the summer contain tax increases that are likely to hurt consumer demand next year. We see a strong possibility that private consumption will contract next year. On the other hand, we consider that the recent weakening of the euro exchange rate, if it persists, could provide somewhat of a boost to Italian exports.
U.K. Continued signs of weakness, such as rising unemployment and deteriorating business surveys, are weighing on the U.K.'s economic prospects. Our forecast from August already reflected our concerns regarding 2012, and we have revised it marginally downward again this month to 1.7% for real GDP growth (from 1.8%). A key uncertainty in the U.K. outlook is the possible impact of a new round of quantitative easing that we believe the Bank of England (BoE) seems about to launch. In response to the intensification of the financial crisis in the final part of 2008, the BoE adopted unconventional monetary policy measures, known as quantitative easing (QE), consisting of financial assets purchases financed by central bank money. Between March 2009 and January 2010, £200 billion of assets were purchased, overwhelmingly government securities, and the equivalent of about 14% of GDP. In its latest Quarterly Bulletin (Q3 2011), the BoE provides what we view as rather positive estimates of the impact of QE on financial markets and the economy. It suggests that the £200 billion of QE depressed gilt yields by about 100 basis points. QE was also associated with a decline in the sterling effective exchange rate of 4%, a help for U.K. exports, according to the BoE bulletin. More broadly, the BoE estimates that QE had a peak effect on the level of real GDP of about 1.5% and a peak effect on annual consumer price index (CPI) inflation of about 1.25%. We believe that in view of the renewed weakness of the domestic economy, the BoE will start a second phase of QE at the end of this year, possibly of a comparable size with that of 2009-2010.
The Likelihood Of A Second Dip Is Rising
Signs of weakening are abundant in European economies. Yet, we still believe that robust demand from emerging markets--albeit not as strong as in 2010--as well as resilient consumers in key markets such as France and Germany and the continued support of monetary policies will help avoid a new recession (double dip) next year. Nonetheless, the downside risks should not be underestimated, in our view. They could conceivably come from financial markets through a fresh rise in long-term interest rates, or from the real side in the form, for instance, of lower growth in emerging markets.
The only question worth asking: does this translate into a warning for the rating of the UK and France? Everything else is noise.