European Recovery Path in Danger as Politics Menace Growth

The euro region’s path to recovery is facing a new challenge from Italy’s political stalemate.

Growth and job-creation in the 17-nation euro area were showing a mixed picture before the results of Italy’s vote sparked a new round of market turmoil on Feb. 26. While German and euro-region business confidence rose in February, services and manufacturing both contracted and the European Commission last week forecast the bloc’s first-ever back-to-back recession in 2013.

The election highlights the risk that Europe’s recovery turns into a slog lasting years, especially if voters continue to stream toward anti-austerity populists such as Italy’s Beppe Grillo, said economists from ABN Amro Bank NV to Daiwa Capital Markets. With European Central Bank interest rates already at record lows, officials may have little choice other than to let Europe grind its way out of the slump.

“Even before the election, it was going to be a much harder story for the periphery to return to growth than for Germany,” said Richard Barwell, senior European economist at Royal Bank of Scotland Group Plc in London. “If the Italy situation goes on for several months, it will begin to put back the European recovery.”

Investors across the euro region recoiled after the party of comedian-turned-politician Grillo won a quarter of the vote with a platform that calls into question Italy’s membership of the euro.

That triggered Italy’s biggest bond-market slide in 14 months, pushing the yield on its 10-year bond as high as 4.9 percent. The yield on Portugal’s bond of similar maturity rose to 6.66 percent and the Greece’s 10-year yield climbed to 11.49 percent.

Waning Optimism

Higher borrowing costs come as some of the economic data in the past two weeks questions the optimism that has charged markets since ECB President Mario Draghi pledged in July to do “whatever it takes” to safeguard the euro.

The euro region contracted 0.6 percent in the fourth quarter, the most since the depths of the 2009 recession, the European Union’s statistics office said Feb. 14. Services and manufacturing contracted at a faster pace than economists forecast in February. And on Feb. 22, the European Commission estimates that the bloc will shrink 0.3 percent this year.


The euro region’s hobbling recovery contrasts with the rally in stocks and bonds since July. The Stoxx Europe 600 Index has jumped about 15 percent since then, while in January, the yield on Italy’s 10-year bond fell to the lowest since December 2010.

Those market rallies were fuelled partly by optimism about Germany’s economy, Europe’s largest. The Ifo gauge of business confidence rose to a 10-month high in February and the ZEW index of investors’ sentiment reached the highest since 2010.

Economic confidence in the euro area increased more than economists forecast in February, the European Commission said yesterday. Its survey was conducted before the Italian election results.

Some economists have also pointed to falling wage costs in Portugal, Spain and Ireland as evidence that governments and executives are slowly refitting their recession-hit economies.

Irish labor costs have dropped 10.4 percent since the euro crisis broke out in 2009, European Commission data shows. In Spain, they have dropped 6.4 percent and in Portugal they have declined 5.8 percent. By contrast, labor costs in Italy have climbed 2 percent in the same period.

Peugeot Plan

Carmaker PSA Peugeot Citroen plan to bolster production at its plant in northern Portugal by 36 percent in 2013 and hire 300 new workers at a plant, the government said Feb. 22. Nissan Motor Co. said Feb. 4 it would build a new car model at its Barcelona plant after reaching an agreement on improved productivity with labor representatives.

At the same time, the European Commission still forecasts that Italy, Spain, Greece and Portugal will contract 1.0 percent or more this year. Firms from Volkswagen AG, Europe’s largest carmaker, to Holcim Ltd., the world’s biggest cement maker, have said that growth in Europe is hurting profit.

“The recovery seems to be confined to some core countries,” said Martin Van Vliet, senior euro-area economist at ING Groep NV in Amsterdam. “We can’t bank on a strong, sustained recovery in the euro zone this year, and the underlying story is one of misery for most countries.”

Youth Unemployment

Domestic politics is holding back many of the most crisis-ravaged countries. In Spain, where youth unemployment is more than 50 percent, the government’s agenda to revamp the economy has been thrown off track by corruption scandals rocking Prime Minister Mariano Rajoy’s party.

Whoever wins the upper hand in Italy’s post-election struggle for power will still be confronted by an economy stuck in its longest recession since 1992. Cyprus’s bid to stave off a bailout that could equal the size of its near 18 billion-euro ($24 billion) economy has been held up by elections.

“The economy is much more influenced by political processes and psychological aspects,” said Stefan Schilbe, chief economist at HSBC Trinkaus & Burkhardt AG in Dusseldorf. “Progress toward more competitiveness is painful. Reforms are going in the right direction but they take time.”

ECB Outlook

No one, including Draghi, said dragging Europe out of recession in the midst of massive structural adjustment would be easy. Even though he said the fourth quarter data was “more negative than expected,” the ECB president stuck to his call that the recovery will appear later this year. That call will be tested on March 7 if the ECB revises its official staff forecasts for growth significantly downwards.

Draghi is keen to remind investors how far the euro area has come since he pledged to do whatever it takes to keep the single currency together last July. The ECB’s Outright Monetary Transactions plan -- still unused -- is what is allowing the region to even talk about recovery in the first place, said Nick Kounis, head of macro research at ABN Amro in Amsterdam.

“The crisis is over in some sense, but for the real economy the hangover is still very much with us,” he said. “The consolidation, the budget cuts, the deleveraging, is still ongoing. We’re heading in the right direction, albeit at a very slow pace. It may take until the second half of the decade before things look up.”

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