Growth in the eurozone cannot pick up due to the destructive effects of a long recession, writes Patrick Artus, chief economist at Natixis
The economic crisis in the eurozone (excluding Germany) has been dragging on for five years and has become deep-rooted – lasting far longer than most recessions. Indeed, eurozone activity fell for a sixth consecutive quarter at the beginning of the year. And while the recession continues to deepen in the periphery, the economic slowdown has reached the core, what with Germany barely growing and the French recession being confirmed by another negative GDP change in the first quarter of this year (i.e. -0.2% quarter-on-quarter).
If this were a shorter recession – such as that seen at the turn of the 21st century – analysts would need only consider seven possible indicators of economic recovery: an improvement in surveys regarding future production or consumer confidence, a pick-up in business investment, an increase in production capacity, an upturn in building permits and residential investment, a fall in the household savings rate and an increase in household credit.
The effects of a ‘long’ recession are preventing a pick-up in growth
Yet, the fact the eurozone cannot reap more permanent positive economic results becomes understandable when you consider the extent of the current recession, which has been occurring and has become self-fulfilling. Because the recession has lasted so long, additional negative effects have arisen that wouldn’t usually appear during a shorter recession. And it’s these effects that are preventing a pick-up in growth throughout the eurozone.
The first effect to draw attention to is the loss of potential GDP. In a long recession, domestic demand is permanently weakened, so it’s common for companies to considerably reduce productive investment – more so than they would in a shorter recession. Moreover, companies use up their reserves when their business is suffering, and bankruptcies become more frequent as a result. Due to the decline in investments, there is a decline in industrial production capacity and therefore potential GDP. And this decline in potential GDP prevents any significant recovery in economic activity.
The second effect of a long recession is the loss of human capital, clearly due to persistently high headline unemployment, long-term unemployment and – in particular – youth unemployment. Unemployment rates have never been so high across the European Monetary Union (EMU) – at 12.2% on average – while youth unemployment is particularly alarming in the peripheral countries (e.g. 70% in Greece, 50% in Spain). Unsurprisingly, if there is high unemployment there is a slowdown in labour productivity and total factor productivity – which also affects potential growth. If there is a decline in both the level of potential GDP and potential growth, actual GDP cannot regain momentum.
And thirdly, a persistent decline in activity causes a sharp deterioration in public finances, which, after some time, leads to a restrictive fiscal policy. Fiscal policy therefore becomes pro-cyclical, which is not the case in a short-lived recession (for example: the eurozone’s fiscal deficit was reduced from 2004, once growth had already picked up following the recession in the early 2000s).
The fear of a resurging eurozone crisis still lingers
Of course, a common concern gripping the markets is the possibility of an exacerbated – and even longer – eurozone crisis. Such thoughts have taken shape due to four potential market shocks: the possible removal of the European Central Bank’s ability to use the Outright Monetary Transaction programme for large amounts (thereby rendering it largely ineffective); the expectation of a restructuring of public debt for countries with unsustainable public debt ratios (triggering a return to high correlations between sovereign debt and bank debt); an adjustment in the cost of corporate debt to the real level of credit risk; and, finally, the discovery – potentially during the ECB-led Asset Quality Review of Europe’s banks later in the year – of an unexpected need to recapitalise banks, the cost of which could be borne by governments.
Incidentally, it seems the onset of recessions can no longer be linked to the customary inflation and monetary policy cycle. Instead, recessions have – since the end of the 1990s – been triggered by the bursting of asset price bubbles and by the resulting banking crises (with the eurozone’s recession being a key example). Such a theory could also explain the magnitude of more recent recessions and why the scale of central bank intervention to stabilise activity has also stepped up (e.g. the ultra-expansionary monetary policies currently taking place in the US, UK, Japan and the eurozone). In terms of size, the decline in global GDP was far greater in the recession of the early 2000s than the recession in the early 1990s – and today’s recession has been greater still.
When discussing the practicalities of economic recovery across the eurozone now, however, it’s important to remember that it’s the effects of such a long recession – e.g. GDP continuing to adjust downwards, in addition to a loss of human capital and a pro-cyclical fiscal policy – that have generated its depth and obduracy.
UK might need negative rates if recovery disappoints – BoE’s Vlieghe
By David Milliken and William Schomberg
LONDON (Reuters) – The Bank of England might need to cut interest rates below zero later this year or in 2022 if a recovery in the economy disappoints, especially if there is persistent unemployment, policymaker Gertjan Vlieghe said on Friday.
Vlieghe said he thought the likeliest scenario was that the economy would recover strongly as forecast by the central bank earlier this month, meaning a further loosening of monetary policy would not be needed.
Data published on Friday suggested the economy had stabilised after a new COVID-19 lockdown hit retailers last month, while businesses and consumers are hopeful a fast vaccination campaign will spur a recovery.
Vlieghe said in a speech published by the BoE that there was a risk of lasting job market weakness hurting wages and prices.
“In such a scenario, I judge more monetary stimulus would be appropriate, and I would favour a negative Bank Rate as the tool to implement the stimulus,” he said.
“The time to implement it would be whenever the data, or the balance of risks around it, suggest that the recovery is falling short of fully eliminating economic slack, which might be later this year or into next year,” he added.
Vlieghe’s comments are similar to those of fellow policymaker Michael Saunders, who said on Thursday negative rates could be the BoE’s best tool in future.
Earlier this month the BoE gave British financial institutions six months to get ready for the possible introduction of negative interest rates, though it stressed that no decision had been taken on whether to implement them.
Investors saw the move as reducing the likelihood of the BoE following other central banks and adopting negative rates.
Some senior BoE policymakers, such as Deputy Governor Dave Ramsden, believe that adding to the central bank’s 875 billion pounds ($1.22 trillion) of government bond purchases remains the best way of boosting the economy if needed.
Vlieghe underscored the scale of the hit to Britain’s economy and said it was clear the country was not experiencing a V-shaped recovery, adding it was more like “something between a swoosh-shaped recovery and a W-shaped recovery.”
“I want to emphasise how far we still have to travel in this recovery,” he said, adding that it was “highly uncertain” how much of the pent-up savings amassed by households during the lockdowns would be spent.
By contrast, last week the BoE’s chief economist, Andy Haldane, likened the economy to a “coiled spring.”
Vlieghe also warned against raising interest rates if the economy appeared to be outperforming expectations.
“It is perfectly possible that we have a short period of pent up demand, after which demand eases back again,” he said.
Higher interest rates were unlikely to be appropriate until 2023 or 2024, he said.
($1 = 0.7146 pounds)
(Reporting by David Milliken; Editing by William Schomberg)
UK economy shows signs of stabilisation after new lockdown hit
By William Schomberg and David Milliken
LONDON (Reuters) – Britain’s economy has stabilised after a new COVID-19 lockdown last month hit retailers, and business and consumers are hopeful the vaccination campaign will spur a recovery, data showed on Friday.
The IHS Markit/CIPS flash composite Purchasing Managers’ Index, a survey of businesses, suggested the economy was barely shrinking in the first half of February as companies adjusted to the latest restrictions.
A separate survey of households showed consumers at their most confident since the pandemic began.
Britain’s economy had its biggest slump in 300 years in 2020, when it contracted by 10%, and will shrink by 4% in the first three months of 2021, the Bank of England predicts.
The central bank expects a strong subsequent recovery because of the COVID-19 vaccination programme – though policymaker Gertjan Vlieghe said in a speech on Friday that the BoE could need to cut interest rates below zero later this year if unemployment stayed high.
Prime Minister Boris Johnson is due on Monday to announce the next steps in England’s lockdown but has said any easing of restrictions will be gradual.
Official data for January underscored the impact of the latest lockdown on retailers.
Retail sales volumes slumped by 8.2% from December, a much bigger fall than the 2.5% decrease forecast in a Reuters poll of economists, and the second largest on record.
“The only good thing about the current lockdown is that it’s no way near as bad for the economy as the first one,” Paul Dales, an economist at Capital Economics, said.
The smaller fall in retail sales than last April’s 18% plunge reflected growth in online shopping.
BORROWING SURGE SLOWED IN JANUARY
There was some better news for finance minister Rishi Sunak as he prepares to announce Britain’s next annual budget on March 3.
Though public sector borrowing of 8.8 billion pounds ($12.3 billion) was the first January deficit in a decade, it was much less than the 24.5 billion pounds forecast in a Reuters poll.
That took borrowing since the start of the financial year in April to 270.6 billion pounds, reflecting a surge in spending and tax cuts ordered by Sunak.
The figure does not count losses on government-backed loans which could add 30 billion pounds to the shortfall this year, but the deficit is likely to be smaller than official forecasts, the Institute for Fiscal Studies think tank said.
Sunak is expected to extend a costly wage subsidy programme, at least for the hardest-hit sectors, but he said the time for a reckoning would come.
“It’s right that once our economy begins to recover, we should look to return the public finances to a more sustainable footing and I’ll always be honest with the British people about how we will do this,” he said.
Some economists expect higher taxes sooner rather than later.
“Big tax rises eventually will have to be announced, with 2022 likely to be the worst year, so that they will be far from voters’ minds by the time of the next general election in May 2024,” Samuel Tombs, at Pantheon Macroeconomics, said.
Public debt rose to 2.115 trillion pounds, or 97.9% of gross domestic product – a percentage not seen since the early 1960s.
The PMI survey and a separate measure of manufacturing from the Confederation of British Industry, showing factory orders suffering the smallest hit in a year, gave Sunak some cause for optimism.
IHS Markit’s chief business economist, Chris Williamson, said the improvement in business expectations suggested the economy was “poised for recovery.”
However the PMI survey showed factory output in February grew at its slowest rate in nine months. Many firms reported extra costs and disruption to supply chains from new post-Brexit barriers to trade with the European Union since Jan. 1.
Vlieghe warned against over-interpreting any early signs of growth. “It is perfectly possible that we have a short period of pent up demand, after which demand eases back again,” he said.
“We are experiencing something between a swoosh-shaped recovery and a W-shaped recovery. We are clearly not experiencing a V-shaped recovery.”
($1 = 0.7160 pounds)
(Editing by Angus MacSwan and Timothy Heritage)
Oil extends losses as Texas prepares to ramp up output
By Devika Krishna Kumar
NEW YORK (Reuters) – Oil prices fell for a second day on Friday, retreating further from recent highs as Texas energy companies began preparations to restart oil and gas fields shuttered by freezing weather.
Brent crude futures were down 33 cents, or 0.5%, at $63.60 a barrel by 11:06 a.m. (1606 GMT) U.S. West Texas Intermediate (WTI) crude futures fell 60 cents, or 1%, to $59.92.
This week, both benchmarks had climbed to the highest in more than a year.
“Price pullback thus far appears corrective and is slight within the context of this month’s major upside price acceleration,” said Jim Ritterbusch, president of Ritterbusch and Associates.
Unusually cold weather in Texas and the Plains states curtailed up to 4 million barrels per day (bpd) of crude production and 21 billion cubic feet of natural gas, analysts estimated.
Texas refiners halted about a fifth of the nation’s oil processing amid power outages and severe cold.
Companies were expected to prepare for production restarts on Friday as electric power and water services slowly resume, sources said.
“While much of the selling relates to a gradual resumption of power in the Gulf coast region ahead of a significant temperature warmup, the magnitude of this week’s loss of supply may require further discounting given much uncertainty regarding the extent and possible duration of lost output,” Ritterbusch said.
Oil fell despite a surprise drop in U.S. crude stockpiles in the week to Feb. 12, before the big freeze. Inventories fell by 7.3 million barrels to 461.8 million barrels, their lowest since March, the Energy Information Administration reported on Thursday. [EIA/S]
The United States on Thursday said it was ready to talk to Iran about returning to a 2015 agreement that aimed to prevent Tehran from acquiring nuclear weapons. Still, analysts did not expect near-term reversal of sanctions on Iran that were imposed by the previous U.S. administration.
“This breakthrough increases the probability that we may see Iran returning to the oil market soon, although there is much to be discussed and a new deal will not be a carbon-copy of the 2015 nuclear deal,” said StoneX analyst Kevin Solomon.
(Additional reporting by Ahmad Ghaddar in London and Roslan Khasawneh in Singapore and Sonali Paul in Melbourne; Editing by Jason Neely, David Goodman and David Gregorio)
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