Euro Area 2010: Signs of Recovery Amid Escalating Fiscal Woes |
Fourth Quarter: Fiscal Tensions
Following the slowdown witnessed in the third quarter, data started to show some improvement, yet it remained below the second quarter’s levels, while the main concern was calming fiscal woes that aggravated during the quarter.
The problem this time shifted to Ireland that recorded the highest deficit in the euro zone in 2009 after the Irish government announced it may need up to 50 billion euros to have more control of Anglo Irish Banks and increase cash in Allied Irish Bank as both need to raise capital by nearly 14.4 billion euros.
Worries persisted thereafter as the Irish government said it will need an aid from the EU to trim the huge deficit, causing Irish versus German 10-year bond yields to surge and cost of insuring against default to rise to records and the same for the Portuguese and Spanish long-term spreads on fraught outlook in the region's most indebted countries.
Standard & Poor's afterwards lowered Ireland's long-term sovereign rating to A from AA- and short-term rating to A-1 from A-1+1 with negative outlook.
Also, Moody's Investor Services downgraded Spain's top rating by one notch to "Aa1" from "Aaa," as a result of the bleak outlook for Spain amid the sharpest deficit cut plans in three decades announced by Prime Minister Jose Luis Zapatero.
On November 21, the Irish Prime Minister accepted to get an aid package from the EU and IMF to restructure the fragile banking system and tame the skyrocketing sovereign debt.
The Irish Prime Minister Brian Cowen announced a four-year austerity plan ending 2014 to set aside 15 billion euros in savings as the government intends to introduce welfare cuts of 2.8 billion euros and income tax increases of 1.9 billion euros.
By the end of November, the EU and IMF said they will provide Ireland with 85 billion euros aid package which would be financed through 45 billion euros from European governments, 22.5 billion euros from the IMF and 17.5 billion euros from Ireland's cash reserves and national pension fund. In addition, UK will provide its neighbor with 3.8 billion euros.
This will allocate 10 billion euros from the package to re-capitalization, and 35 billion to support the banking system, with an additional 50 billion euros for the remaining needs of the country's budget.
The aforesaid loans will be with 5.8% interest while the EU gave the debt-ridden economy to set budget deficit at the 3% limit by 2015 instead of 2014.
The plan also contained items of broad rescue plan as well as indirect assistance to Greece as well; Greece granted four and a half years extra to pay off their emergency loans of $110 billion euros to match the seven years given to Ireland under the agreement.
In addition, Finance Ministers agreed on German-French proposal for the adoption of a permanent mechanism called European Stability Mechanism (ESM) to resolve crises beyond mid 2013, after the expiry of the European Financial Stability Facility, through making investors participate in incurring losses in return for compensation for the assistance received from taxpayers.
However, the Irish rescue plan failed in lowering tensions that rose after Fitch downgraded Ireland's credit for the second time in two months by three notches to BBB+ from A+ with "stable" outlook.
Trichet said the lifeline package may be increased if needed, but in the latest meeting by European Finance Ministers they agreed to rule out any rescue for Portugal and Spain or to expand the 750 billion-euro package announced in May, while Germany rejected issuing European joint bonds.
Thereafter, the last European leaders meeting in 2010 came up with an agreement among European economies to put a permanent fund starting from 2013 after the expiry of the European financial stability Facility, while Germany proposed to offer financial aid if it is very necessary where bondholders would participate in some costs of future bailouts, while it refused expanding the 750 billion euros lifeline introduced in May.
On the other hand, the ECB mentioned that it will increase capital by 10.7 billion euros starting from December 29.
Sectors Performance
Amid the fiscal woes in the region, European manufacturing and services continued their expansion in the quarter. PMI Manufacturing index for the month of November rose to 55.3 from 53.7 in September. In Germany, the index rose to 58.1 from the prior 56.6 reported in October. France’s manufacturing sector’s activities rose to 57.9 from 55.2, while Italy’s gauge fell to 52.0 from 53.0.
On the other hand, Spain's manufacturing stagnated and the Greek sector contracted, while in Ireland the index came in at 51.2.
PMI services also expanded further in November to 55.4 from 54.1 in September. Services PMI in Germany surged to 59.2 in November from 56.00 in October.
The improvement was supported partly by the euro's 6.9% drop in November versus the dollar as well as the improved demand from major and emerging economies.
The EURUSD pair opened the month of November at 1.3960 while it closed at 1.2982.
Moreover, most European indices after advancing in October fell sharply in November with the rise of the Irish debt and fiscal woes which overshadowed the positive impact of the progress in third-quarter earnings by most European companies.
DJ STOXX 50 opened at 2741 points in October while plummeted to a low of 2633 points in June, the French CAC 40 started with 3729.5 points in October to sink to a low of 3588.5 in November. German DAX 30 opened the month of October at 6621.8 while continued rising in November where it reached a high of 6908.8.
Unemployment
Despite the improvement seen in key sectors, unemployment rose to the highest level in more than 12 years to 10.1% in October from 10.0% in September as European companies were wary of adding employees; elevating energy costs threaten to restrain profit margins and euro-area governments set to start severe budget cuts which lid capital expenditure.
October's report showed that around 15.95 million people in the euro region were unemployed, higher 80,000 from September. The high rate was triggered by the 20.7% recorded in Spain while the lowest level was at 4.4% in Netherlands.
Inflation
Prices continued its acceleration in the fourth quarter as it reached 1.9% in October and November boosted by the remarkable rise in crude oil prices that hit a high of $89.05 a barrel in November.
The rate is now very close to the 2% target set by the ECB, yet facing downward pressure from the high unemployment rate.
ECB Monetary Decision
The ECB left interest rate unchanged in the three months ending December to boost recovery that started to slow in the second half.
In October, the bank highlighted that it will keep its position on refinancing operations unchanged on one-week and one-month mode of full-allotment at fixed rate.
In December, the Governing Council decided to "continue conducting its main refinancing operations and the special-term refinancing operations with a maturity of one maintenance period as fixed rate tender procedures with full allotment for as long as necessary, and at least until the end of the third maintenance period of 2011 on 12 April 2011, whereas the three-month longer-term refinancing operations to be allotted on 26 January, 23 February and 30 March 2011 as fixed rate tender procedures with full allotment."
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