German, U.K. Budget Cuts May Drive Europe Back Into Recession, Pimco Says

Europe risks falling back into recession as nations such as Germany and the U.K. cut budgets sooner than expected, justifying an “underweight” position on the euro and pound, said Pacific Investment Management Co., which runs the world’s largest bond fund.

“It’s a growing risk,” Scott Mather, Pimco’s head of global portfolio management, said yesterday in a Bloomberg Television interview from Newport Beach, California. “Austerity is being pulled forward.”

The European Union aims to slash national budget deficits after being forced to take unprecedented steps to stem a debt crisis. In early May, European governments crafted a 110 billion-euro ($138 billion) emergency aid package for Greece after the country was cut off from debt markets. A week later, the governments also established a 750 billion-euro financial backstop for the euro area as a whole following an increase in borrowing costs for Spain and Portugal.

The EU goal is to avert a debt default, preserve the 11- year-old European single currency and push budget deficits below the EU’s limit of 3 percent of gross domestic product.

“There are parts of Europe where austerity wasn’t called for immediately,” said Mather, who mentioned Germany and the U.K. as examples. “We’ve been a bit surprised by how quickly even countries that don’t have austerity forced upon them by the market are willfully heading down that path.”

Growth Forecast

The euro-area economy will probably grow 0.9 percent this year and 1.5 percent in 2011 after declining 4.1 percent in 2009, the European Commission, the EU’s Brussels-based executive arm, said on May 5 in a semi-annual forecast.

The fiscal tightening across Europe “is leading people to worry about where the growth will come from, not just next year but in the next six months,” Mather said. “It’s made us bring forward our expectations for a drop in growth and a drop in inflation within the euro zone.”

Partly for these reasons, Pimco is sticking to an underweight stance that the company has had on the euro and the pound “for quite a period of time,” he said. Mather said possible further economic and political “tensions” in the euro area pose extra risks for the European single currency.

An underweight position means investors hold a smaller portion of those assets in their portfolios than are included in benchmark indexes.

“We still think an underweight position is warranted,” Mather said. “There are a lot of headwinds for the euro ahead.”

To contact the reporter on this story: Sara Eisen in New York at seisen@bloomberg.net

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