The Outlook for the US and European Economies in 2009
- Europe and America set for negative growth as financial unease continues -
November 19, 2008
The sub-prime loans problem has developed into a severe financial system crisis centering on Europe and the United States. A range of countermeasures that includes injections of public funds by the governments of the United States and Europe has gone some way to relieving the tension, but the fall in housing prices and the economic downturn mean that the losses posted by financial institutions are highly likely to continue rising and the financial crisis is not expected to be easily resolved. The spread of the crisis to the emerging economies, especially those of central and eastern Europe, will place an additional burden on European banks, which have substantial credit exposure to these regions.
Given these circumstances, let us consider the three key points in any attempt to forecast the future movement of the US and European economies in 2009:
(1) How soon the financial crisis and housing price adjustment come to an end
The resolution of the financial crisis requires that the fall in housing prices be checked, at least in Europe and the United States. One factor in the fall in housing prices in the United States is the rise in supply due to houses repossessed by banks being sold off. Assuming that such selling-off remains at a tolerable level, it is estimated that housing prices will once more begin to rise year-on-year some time from the autumn of 2010 onwards.
In the euro-zone and the United Kingdom, housing prices are thought to be too high, respectively by 15% and 30%, as compared with disposable income. The housing price adjustment has yet to begin in earnest in the euro-zone and is not expected to be completed before early 2010 at the earliest. In the United Kingdom, where prices have already fallen by more than 10% year-on-year, the adjustment is not expected to come to an end before mid-2010.
(2) The impact of the financial crisis on the real economy
With financial institutions in the United States and Europe taking a stricter lending stance due to the financial crisis, capital investment is likely to see a substantial fall in both the United States and Europe, up to mid-2009. In the United States, against a background of unprecedented levels of household debt, the pressure to repay debts is likely to increase. As American households have a debt overhang of around 20% as compared to their disposable income, consumption may well stagnate for the next 3-5 years.
In the euro-zone, too, the growth of household borrowing in conjunction with the housing boom has boosted consumption for the past few years and consumption growth is likely to remain at zero while debt adjustment continues. Even in the United Kingdom, the growth of debt since 2006 has pushed the savings rate down by 5 points, and it is likely that a corresponding rise in the savings rate will be required.
(3) The countermeasures taken by the new Obama Administration
President-elect Barack Obama has said he will put forward positive measures to revitalize the economy. Although measures worth $150-200 billion are apparently being considered, avoiding a further worsening of the employment situation would require measures to stimulate demand equivalent to 3% of GDP, and they are likely to do little more than prevent the bottom from dropping out of the economy.
Europe has started to address economic stimulus measures, but the measures currently being considered are chiefly designed to relieve the cashflow problems of small and medium enterprises, and the boost they provide to demand will be extremely limited.
The outlook for the US and European economies is as follows:
United States: With the vicious circle of turmoil in the financial markets and deterioration of the real economy taking effect, the economic downturn is set to continue. Negative growth is set to continue into spring 2009, which will bring policy changes in conjunction with the change of administration. From spring 2009 onwards, although the downward trend of the economy will temporarily be checked by the measures introduced by the new Obama Administration, that trend is unlikely to become a vigorous recovery and the sense of stagnation is likely to remain extremely strong. Europe: In the euro-zone, with economic stimulus measures bringing limited benefits, (i) the stagnation of consumer spending due to the sharp deterioration of the employment situation and the adjustment in housing prices beginning in earnest and (ii) the downturn in capital investment due to sluggish demand and continued financial unease, among other factors, mean that the economic downturn is likely to continue for several quarters to come. In the United Kingdom, too, (i) the stagnation of consumer spending owing to the sharp deterioration of the employment situation and household balance sheet adjustments and (ii) the slump in finance and real estate, which have been the engines of growth, among other factors, make it likely that significant negative growth will continue for several quarters to come.
The risk factors in the above scenario are (i) an acceleration in the downward trend of the value of the dollar and (ii) a rise in long-term interest rates, due to the major expansion of the US fiscal deficit. If these risks materialize, there is a danger that the effects of the vicious circle of turmoil in the financial markets and deterioration of the real economy will be amplified still further.
For more information on the content of this report, please contact Takeshi Makita, the Japan Research Institute, Limited.