DEVELOPED EUROPE: ECONOMIC REVIEW SEPTEMBER 2011

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Germany: Manufacturing sector growth continues to slow down

Until recent months, Germany appeared to remain insulated from the Euro-zone sovereign debt crisis. However, data released recently indicated a loss of momentum in Europe’s largest economy. For example, September saw the country’s manufacturing sector expanding at its slowest rate in two years. Markit’s PMI for the sector remained in a downtrend for the fifth consecutive month, falling to 50.3, a level just a few notches above 50, which divides growth from contraction. Not too long ago, the index stayed above 60 for five whole months between December 2010 and April 2011, in a sign of extremely strong growth.

More worryingly for the export-driven German economy, the sub-index for new export orders touched 45.1 in September, reflecting the strongest monthly decline since June 2009. Releasing the sub-index, Markit remarked that owing to “weaker economic conditions, an uncertain outlook for global demand, and concerns about the euro area debt crisis,” clients of German exporters had apparently slowed down spending in September. Significantly, Germany was the only Euro-zone economy to record growth, albeit small, in its manufacturing sector. All other economies registered a decline.

The loss of momentum in Germany’s manufacturing and exports sector seems to be taking a toll on business confidence in the country, which weakened for the third consecutive month in September. The Munich-based research institute Ifo’s business climate index declined to 107.5, the lowest level in 15 months, during the review period from 108.7 in August. The index had touched a record high of 115.4 in February. Providing an interpretation of the index’s steady fall, an Ifo economist said that German firms appeared to be worried about “what would happen if the financial crisis intensified or Greece or another country became insolvent.”

Defying the sense of pessimism in the manufacturing sector, the nation’s labor market remained robust. The Bundesbank reported that the nation’s unemployment rate, adjusted for seasonal variations, slipped from 7.0% to 6.9% in September. Unemployment is considered a lagging indicator of a country’s economic health. Therefore, it remains to be seen whether the current slowdown in manufacturing sector growth has had any impact on the labor market.

U.K.: New stimulus measures announced

As September ended and the U.K. stepped into the fourth quarter, several positive developments greeted the country. For instance, the Chancellor of the Exchequer, George Osborne, announced a new “credit easing” initiative under which the U.K. Treasury would buy corporate bonds issued by small and midsize companies. The move is expected to ease the liquidity concerns of businesses struggling to get loans from banks. Notably, though, it is not common for small firms to issue bonds. However, according to the Wall Street Journal, the U.K. government is likely hoping to create the necessary demand conditions for such bonds to be issued in the future.

Meanwhile, the Bank of England announced the expansion of its quantitative easing (QE) policy. At a two-day meeting, members voted to increase the central bank’s asset purchase program by £75 billion to £275 billion over a four-month period. They also decided to keep the benchmark interest rate at 0.50%.

Markit’s U.K. manufacturing sector PMI for September showed a slight improvement over August figures. Against expectations that it might fall further, the index inched up to 51.1 from 49.4 in August, indicating modest growth in the sector during the review period. Ever since touching 61.4 in January, the PMI has remained more or less in a downtrend and there was speculation that the indicator might deteriorate due to the problems in the Euro-zone, which is home to many of the U.K.’s trading partners. On a disappointing note though, other Markit data indicated a decline in new orders, the first since February 2010, in the U.K.’s construction sector. The construction PMI fell to 50.1 in September from 52.6 in August, with residential construction weakening and commercial construction activity improving a bit.

An index created by accountancy firm BDO based on various surveys of confidence and business climate in the U.K. increased to 95.5 for August from 95.1, signaling a moderate rise in business confidence in the country.

France: Sentiment and confidence indices deteriorate

Early in October, France and Belgium stepped forward to rescue the Franco-Belgian bank Dexia, which has turned out to be the first financial sector victim of the Euro-zone sovereign debt crisis. The governments of France and Belgium had become shareholders in the bank after contributing to its rescue at the height of the 2008 financial crisis. This time around, the countries have been forced to provide guarantees worth around €90 billion to secure Dexia’s borrowing over the next 10 years because short-term funding for the bank has dried up owing to concerns about its troubled assets. The move has brought to focus the pressure Euro-zone governments face to strengthen their banks.

A series of other data released in September showed that much like the rest of the Euro-zone, the French economy is losing momentum, and consumer and business confidence in the nation remains subdued. While the Bank of France reported that GDP growth in the country was just 0.1% in the third quarter, the French statistics office Insee said that its index of sentiment in the country’s manufacturing sector declined to its lowest level since August 2010 in September.

Insee also reported that its household confidence indicator fell to 80 in September from 82 in August owing to worries about employment. Its index of business confidence plummeted to 99 points in September from 105 in July due to weakening business prospects. Markit’s PMI for the French manufacturing sector substantiated the Insee data, falling to 48.2 in September from the three-month average of 49.3.

Italy: New austerity package gets parliamentary approval

In a step signaling Italy’s determination to improve its fiscal health, Prime Minister Silvio Berlusconi managed to win parliamentary approval for the €54 billion austerity package his government adopted during August. His government was forced to announce the austerity measures in exchange for the ECB’s commitment to begin buying Italian sovereign bonds after they suffered a particularly prolonged phase of price decline.

However, the approval of the austerity package was far from smooth as it had to be watered down substantially to make it palatable for the majority of Italy’s parliamentarians. As it stands today, the package entails a 1% rise in the country’s value-added tax (VAT) to 21%, an increase in the pensionable age for women, and a 3% “solidarity tax” on Italians earning in excess of €300,000 a year, among other provisions. The austerity package is expected to balance Italy’s budget by 2013.

On a discouraging note, though, Italy’s government bonds were subjected to a series of rating cuts during the review period. While S&P reduced the country’s creditworthiness one notch to A from A+, Fitch cut its rating of Italian debt to A+ from AA-. In other not-so-positive developments, the Italian services sector showed a sharp decline in activity for the fourth consecutive month in September. The Markit/ADACI Business Activity Index, which takes into account the entire gamut of service firms, plunged to 45.8, its lowest level since July 2009, from 48.4 in August. In line with this data, consumer confidence in the country too weakened in September. Amid worries that the country would slip into another recession, the consumer sentiment index compiled by the national statistics office, Istat, declined to its lowest point in more than three years, from 100.3 in August to 98.5.

Spain: Government bond yields fall steadily

Besides Italy’s new austerity measures, the steady fall in the yields of Spanish government debt throughout September also played a role in pacifying investors worried about some of the larger Euro-zone economies at the heart of the debt crisis. In fact, during the first week of October, the country managed to meet its maximum target for government bond sales after successfully auctioning debt worth €4.5 billion.

With the ECB consistently buying Spanish debt on the secondary market since August, the yields on Spain’s benchmark 10-year bond fell from their euro-era high of 6.3% recorded in July to below 5% in the first week of October. Rising yields had pushed up Spain’s borrowing costs considerably before the ECB move. The Spanish Economy Minister’s announcement that the country remained on track to narrow down its public deficit to 6% of GDP this year without additional measures also cheered the investment community. Over the past few quarters, the nation has adopted the strictest austerity measures in three decades to cut its budget deficit.

In sharp contrast to these positive developments, the number of jobless claims in the country rose sharply in September as its employment-friendly holiday season ended. Certain days in the month recorded as many as 10,000 claims, Deputy Labor Minister Mari Luz Rodriguez told the Wall Street Journal. Jobless claims increased 2.3% in September compared to August and 5.2% year-on-year. Spain’s last recorded unemployment rate stood at 21.2%, the highest in the developed world.

Greece: Protests intensify against austerity measures

As the world fretted over whether Greece could avoid defaulting on its debt, thousands of Greeks from all sections of society took to the streets in protest against the extremely painful spending cuts and austerity measures Prime Minister George Papandreou’s administration has been implementing in exchange for bailouts from the international community. Around 10,000 marchers assembled in the center of Athens on October 5^th to demonstrate against austerity measures. The protests included a one-day strike in the public sector, which brought the Athens International Airport, ministries, and schools to a complete standstill. Hospitals were forced to run on skeleton staffs, and some rail services had to be shut down. The majority of the protestors were public sector workers who are livid that up to 40% of their take-home pay has been cut.

The government’s recent announcements have deepened the resentment. For instance, the finance ministry has declared that another 100,000 of the better-paid among public sector workers will lose a further 20% of their take-home salaries. What is worse, the government has said that around 30,000 people would be retired to reduce operating costs by €300 million in 2012. The budget for 2012, presented to parliament in early October, also envisions close to €5 billion worth of spending cuts, which public sector unions fear will result in additional layoffs.

Worryingly, despite these spending and job cuts, the Greek government has declared that it will miss its budget-deficit-reduction target for this year. According to the finance ministry, the country’s deficit in 2011 is expected to be 8.5% of GDP or about €18.69 billion, while the target for this year is €17.1 billion. In 2012, Greece is aiming to reduce its deficit to 6.8% of GDP or around €14.65 billion.

Ireland: Labor market outlook “positive”

Ireland’s skilled workforce and its deliberate policy of labor-cost reduction over the past several quarters seem to be bearing fruit. According to Ibec, a group representing Irish businesses, at least 25% of employers in the country will be prepared to recruit new staff in the fourth quarter. Ibec has said that its latest business sentiment survey showed that the employment outlook remains optimistic in Ireland despite the recent turmoil in the region. It appears that “companies have won customers in both new and existing markets” recently, and Ibec added that firms that were most confident about their business prospects were medical devices manufacturers and those in the hospitality sector. The majority of retailers had a negative outlook, the business group noted.

Contrary to this sentiment, though, data reported from the manufacturing sector corroborated the general trend in Developed Europe. The NCB Purchasing Managers’ Index for the Irish manufacturing sector slipped to 47.3 in September from 49.7 in August, owing to a fall in export orders and weakening demand in the global market. This is the first time in 11 months that new export orders declined in the country, as indicated by the index.

In line with Irish retailers’ pessimistic outlook, consumer sentiment in the country appears to be weakening. The overall KBC Bank Ireland/ESRI Irish Consumer Sentiment Index diminished to 53.3 in September from 55.8 in August. The index stood at 52.4 in September 2010.