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Is it the sunshine after the storm for the economies of Europe?

In the last year, a series of game changers has left an indelible mark on economies and coalesced to turn a bad recession into the worst in several generations.

The contractions in recent quarters have been by far the worst and fastest on record, plunging European economies deep into recessionary territory.  More recently, however, we have seen some sunny spots, especially in financial markets and also in the real economy.  

First, distress in financial markets has eased, capital buffers have been shored up and some risk appetite has returned as authorities stepped in to buttress financial systems and the real economy.  But toxic assets remain a troubling issue, particularly on the continent; while lending conditions are still tight. Further fallouts on banks’ balance sheets can be expected due to the force of the recession and the lagging nature of some key variables – unemployment and defaults.

Secondly, we know that perception is as influential as reality in driving the economy. So the recent uptick in economic sentiment is an important and necessary condition for a recovery.  If this trend becomes entrenched, then the recovery will gain traction. But it can only be sustained with a full resolution of all financial troubles, and a bottoming out of trends in trade, labour and housing markets.    

So, although by no means a certainty, we are cautiously encouraged by recent data improvements and anticipate that the global economy looks set to slowly climb out of its deepest, darkest hour in a lifetime.  In Europe the ‘Great Recession’ still has further to run for now. But we expect the rebound to slowly emerge towards the turn of the year, with limited growth in 2010 followed by strengthening positive growth momentum in 2011-13.

Emerging trends

There will be country differences of course, some of which are already emerging. We think that the UK is likely to come out first closely followed by some of the Nordic economies. The key eurozone economies will also follow suit, though export-oriented countries have suffered a colossal blow.  Meanwhile the adjustment to recent shocks will last longest in the so-called PIIGS (Portugal, Ireland, Italy, Greece and Spain), as housing, construction and consumer spending bubbles burst, and imbalances duly play out.

In central and eastern Europe the contrasts are starker. Those countries that have been bailed out by the IMF, and those teetering on the brink of financial crisis, will see further sharp declines in activity with modest growth likely returning in 2011 at the earliest. While no country in the region will emerge unscathed, the central European stalwarts will fair far better, especially as indigenous demand, particularly in Poland, is proving rather resilient and was less credit-dependent than in the rest of the region.

Central Europe also will rebound quickly once growth becomes more pronounced in key western European markets. Slovakia fits that bill as well, although the ‘Detroit of eastern Europe’ has been hard hit in recent months by the slump in the global automotive industry.

Outcomes

Overall, it won’t be another nice decade.  All countries are likely to suffer downward revisions to their natural speed limits, particularly in those countries where we have seen unsustainable booms. Public sector belt-tightening, consumer debt, some migration reversals and tighter regulation and monetary policy will accentuate these speed cuts and imply a tougher business environment in the years ahead.

Mature markets in northern and central Europe are a safer bet in the short to medium term, with the UK and France in particular doing surprisingly well. Chunks of emerging Europe should also offer good returns, especially in central Europe where recession hasn’t been as severe, particularly Poland and the Czech Republic.  

Matthew Sherwood
Senior Global Economic Adviser
Business Strategies
Experian

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