The Euro Area Could Be Heading to a Sharp Recession

Last week, after an unprecedented 75 basis points interest rate cut, the European Central Bank's President Jean- Claude Trichet finally acknowledged that the euro region's economy could shrink in 2009 for the first time since 1993.

In fact, output in the Euro Area fell by 0.2 per cent in both the second and third quarters, with 0.5 per cent contractions in both Italy and Germany. Moreover, in November, manufacturing and service industries contracted at the fastest pace on record and economic confidence plunged to a 15-year low. In addition, unemployment rate is steadily rising, with a 7.7% reading in October and 7.6% in September and is not surging yet because of the less flexible labor market in Europe.

However, in our opinion the worst is yet to come since this recession is different from any previous one. In the first half of the year, the recession was triggered by a surge in the cost of credit, high oil prices and a high value of the euro. But now the slowdown is gaining momentum because of a complete collapse on domestic demand.

Looking ahead, the danger of deflation is possible as consumers start expecting prices to fall. Also, an aggressive monetary policy loosening may be very dangerous for Euro Area as may lead to shift of capital to countries with higher interest rates and keep the EUR/USD under pressure.

The Euro Area Could Be Heading to a Sharp Recession

Anna Fedec,
12/9/2008 7:31:30 AM