The euro zone economy is declining at its fastest pace in almost three years, according to a closely watched survey — increasing the pressure on the European Central Bank (ECB) to ride to the rescue of the troubled currency union with a cut in interest rates.
The May survey of purchasing managers by Markit Economics, published on Thursday, confounded expectations by showing that the ongoing fall in output accelerated in May. On the same day, the prestigious Ifo index of business sentiment in Germany — until now a bright spot amid the euro zone’s economic gloom — showed a sharp fall.
“The broad-based weakness points to a weaker-than-anticipated growth in the second quarter and strengthens our call for an ECB rate cut in the coming months,” said Violante di Canossa, a European economist at Credit Suisse in London. “With the Greek elections scheduled for June 17, it is difficult to see how the surveys can improve.”
The manufacturing sector, which is highly sensitive to changes in economic conditions, is deteriorating particularly fast: the survey’s Purchasing Managers' Index (PMI) for the sector dropped 0.9 points to 45.0. With any number below 50 denoting a contraction, 45 indicates a deep decline. The composite index, which includes private-sector services as well, fell by 0.8 points to a 35-month low of 45.9. The April and May surveys point to a 0.5 percent slide in gross domestic product (GDP) when taken together, according to Markit.
Crucially, conditions have worsened in Germany, whose powerhouse manufacturing sector has hitherto bolstered the currency union’s overall performance. The German PMI index fell from 50.5 to 49.6 — switching from growth to decline. The Ifo index of German sentiment slumped 3 points to 106.9, the biggest monthly slide since August.
Anecdotal evidence suggests that across the euro zone, businesses and consumers have become more reluctant to spend because of the uncertainty created by Greece’s political confusion. Analysts began talking for the first time of the Hellenic Republic’s “probable” departure from the currency union — shifting up a gear from previous talk of “possible” — after the Greek government, which had adhered to the terms of the EU-IMF bailout, lost power in the May general election. With no party able to form a government, a second election is due next month.
The direct effect of a Greek exit from the euro zone will be small — economists estimate that a slump in Greek imports, should its economy and currency collapse in value, will take no more than about 0.2 percentage points off any country’s GDP. However, a greater fear is that a Greek exit would trigger bank runs in other peripheral euro zone economies, such as Italy and Spain, which would be seen as the next most likely candidates to leave the bloc and redenominate their bank deposits in a new currency.
Thursday’s numbers have hardened the conviction among many analysts that the ECB will cut its benchmark refinancing rate, which at 1 percent is significantly above charges at the Federal Reserve and Bank of England. Economists have criticized the ECB for being too slow to ease the cost of borrowing. A cut might boost the economy by reducing the value of the euro, as well by increasing the appetite for loans.
“We think there is a compelling argument for a 50 bp [basis point] rate cut at the June meeting”, said Jens Sondergaard, European economist at Nomura in London — citing Thursday’s evidence of another euro zone slowdown. “But because of the ECB’s history of being reactive rather than preemptive, we stick for now with our current call of no change at the June meeting followed by a 50 bp rate cut in July.”
However, it takes two to tango for rate reductions to have any effect. The ECB’s latest quarterly survey of bank lending, published in April, shows a sharp fall in demand for loans among companies and households — including a vertiginous 43 percent decline in demand for housing loans in the first quarter of this year. The euro zone’s uncertain economic and political situation has, think analysts, left companies and ordinary people reluctant to take on the long-term commitment of a loan.
But there is potential cause for comfort in the fact that the PMI survey has, in recent months, sometimes been gloomier than official numbers that followed. Although the survey shows a fall in output in eight of the past nine months, figures for euro zone GDP growth from Eurostat, the EU’s statistics office, suggest a decline only in the fourth quarter of last year — with output stable in the first quarter of this year. The two sets of figures cover slightly different spheres, since the PMI survey does not include the extraction of natural resources, agriculture, and most importantly government services.
However, with fiscal austerity continuing, government spending will not boost European economies as it has during previous downturns, when politicians allowed deficits to widen to forestall a vicious circle of falling demand and higher unemployment. That is true, at least, unless the new French socialist president François Hollande and other pro-growth leaders cut through the present deadlock to unleash more aggressive pan-European expenditure.
The euro sank to its lowest level since July 2010 on the poor survey news, before recovering to trade little changed on the day at $1.26 by the end of the European afternoon — typifying the week’s whipsaw global trading.
