Continued Austerity to Hamper EU Growth
Allianz Global Investors
By Neil Dwane
December 7, 2011
As 2011 comes to a close, Europe confronts the prospect of policies which will enforce austerity, in the doctrine of German stability and prudence which has already seen Greece, Ireland, Portugal and, later, Italy and Spain enter recession. Austerity will exacerbate this position in 2012 with the U.K. and France also reining in government spending and facing the threat of recession. The special challenge of austerity is to now grow as the tide of rising finance costs hit sovereign debt; for Italy interest costs have now risen above 7%, so growth now needs to exceed 8% just to hold debts flat.
The ECB remains at the heart of market solutions to the EU crisis but has a determined stance against printing the PIIGS (Portugal, Italy, Ireland, Greece and Spain) debt away, without clear and properly supervised central budgeting power over the EU states. As much of a challenge is the symbiosis between the power and support of the Bundesbank, which is already lending 500 billion euros to other EU central banks through the Target system, and their need for a strong, stable currency. While interest differentials still benefit the euro a little, we are surprised the euro has not weakened further, which would aid the weak and strong economies in Europe alike. Moreover, with fundamentals slowing and EU banks deleveraging, we expect the euro to weaken from here and still see an exit from the currency as unlikely for any country, as the exit costs and legal implications are just too awful to contemplate.
Banks remain at the vortex of the EU crisis because they are vulnerable to the burgeoning economic recessions as well as being overleveraged, undercapitalized and overexposed to sovereign debt. The sector remains inextricably interlinked globally, and the liquidity and credit stress within markets will force more pain on banks themselves. Inevitably, they will also inflict more credit crunch pain on the economies, although the scale of EU lending commitments to emerging markets suggests this will also have painful consequences for those economies, too, as well as for trade flows.
Despite all this, there are many industries in which Europe has a strong presence and where there are growing opportunities for corporates: Europe makes what emerging market countries need and many of the luxury goods that consumers aspire to. Over the last 10 years Germany has reduced its exports to the U.S. from 18% to 12% of GDP, while raising its emerging market sales from 15% to 29%. Thus, while growth and austerity will limit opportunities in the euro zone, we see many profitable and growing opportunities for European companies globally.
Neil Dwane, CFA, Chief Investment Officer of RCM Europe, a Company of Allianz Global Investors.
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