Wednesday, May 28, 2008

Slowing European Growth: Tipping Point or Downward Spiral?

Eurozone Faces Inflation Risk as Growth Slows
Euro, Franc, Krona to Benefit From Oil, Barclays Says

While Germany masked Europe's service sector's slowdown with a growth spike in the first quarter, it is evident that the European economy is now slowing drastically as output in May proved to be at its slowest rate since July 2003.

A few key indicators clearly illustrate the decline.  Although Germany's growth rate in April was at its highest in seven months, other European countries' slower growth rates remain unchanged, thus implying stagnation.  The first quarter also marked a sixteen-year high inflation rate, a sign that prices will rise and growth will slow further.  Despite the European Central Bank's desire to keep inflation rates just below two percent, some analysts believe April's rate of 3.3 percent may continue to escalate to four percent.  Further, the eurozone purchasing managers' index has fallen to a five-year low of 51.1 points.  This index gauges the expected level of manufacturing activity.  A value above fifty indicates expansion and a value below fifty indicates deterioration.  Since manufacturing represents roughly a quarter of Europe's GDP, the purchasing managers' index is a significant signal in the European economy.  Finally, the International Monetary Fund predicts European growth to slow from 2.6 percent in 2007 to 1.4 percent in 2008.  

Economists disagree whether these market indicators are signs that the U.S. slowdown, tight credit conditions, and high oil prices have hit European markets.  Economists at Goldman Sachs believe that the effects of the record-high euro and the increased purchasing power accompanying it will take time to stimulate growth, thus the European economy will continue to slow.  

However, some economists believe that May's low growth rate is a tipping point.  The strength of the German industries and resilience of emerging Asian and eastern European economies may serve as a protective shield against the effects of the U.S. economic slowdown.  Other economists look to Europe's compact structure and service-oriented market to minimize the effects of rising oil prices, in addition to the strong positive correlation between European currencies and oil prices.  For example, the euro-dollar correlation with oil is .95; as the price of oil increases, the strength of the euro increases as well.  Although a strong euro can result in decreased exports, it means that the value of the currency is increasing; therefore, European purchasing power is increasing. 

Is May's low growth a tipping point indicating growth or an indicator of a severe economic slowdown similar to the U.S.? 

No comments: