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The Eurozone Economy: Beset by Troubles at Home and Abroad
- Recessionary pressures set to continue at least until 2011 -

February 27, 2009


As the financial crisis that originated in the United States spreads from country to country, the Eurozone economy has been falling into the deep recession.

However, the main reason of the recession is that the four largest Eurozone economies (Germany, France, Italy and Spain) have seen "unbalanced growth" and, around the beginning of 2008, the fragility of this economic growth started to be exposed.

The patterns of growth in these four countries concerned can be divided into two major types:
(i) Spain and France have relied on household spending against the backdrop of a housing bubble.
(ii) Germany and Italy have relied on export growth with global economy’s expansion.

Analyzing the "main engines" of growth in the four major economies makes it easy to guess how severe the economic downturn in the Eurozone will be and the time when economic corrections will finish.

The Spanish housing market
It is estimated that housing prices in the last quarter of 2008 were nearly 30% above the appropriate level. Even with the further income tax cuts, it is likely to take until around mid-2011 to correct the situation and, until then, the downward trend in consumer spending is likely to intensify because of the reverse wealth effect. On the other hand, if the correction of the "excessive housing investment" that had accumulated during the bubble period completes by 2011, real housing investment would fall, for a time, to a level 20% below that recorded in 2008.

The French housing market
Given that housing prices are estimated to be still nearly 30% higher than the appropriate level, it is unlikely that the correction will finish before the end of 2010. Although consumer spending is less sensitive to housing prices than it is in Spain, the growth of the consumer spending is highly likely to remain in the negative range throughout 2010.

German exports
With the sharp downturn in developed economies and the slowdown in emerging economies expected, real exports are likely to see a double-digit fall in 2009. There is also little hope that exports will begin to recover during 2010. Moreover, if the outflow of investment money from nearby emerging countries such as Poland and Russia accelerates still further and those economies increasingly stagnate, German exports will also be severely affected.

Italian exports
Since Italian exports are closely correlated to the economic trend of its five largest export destinations (Germany, France, Spain, the United Kingdom, and the United States), Italy's real exports, like those of Germany, are set for a double-digit fall in 2009 and it is probable that the decline will continue during 2010.

It would also be unwise to expect too much from the policy measures adopted by the governments and financial authorities.

Even if Germany and Italy expand government spending, it is very probable that this will not bring a full-scale recovery of the main engine of their economic growth (external demand).
With the fear of worsening supply-demand conditions in the government bonds market strengthening, there is even a risk that future expansion of government spending will rather curb private investment by a rise in long-term interest rates.

Thus, with little immediate prospect of the four largest economies escaping their present predicament and policy measures likely to be of little benefit, the Eurozone is unlikely to see an economic upturn before the end of 2010. During 2009, the real economic growth rate for the Eurozone is expected to sink to nearly -4%, mainly led by the big fall of export-dependent Germany and Italy.
The downward trend in Germany and Italy will ease by some extent in the second half of 2010, but the pace of economic adjustments is set to remain in France and Spain, therefore, economic growth rate for the Eurozone in 2009 is expected to fall to below -1%.

For more information on the content of this report, please contact Ishikawa or Tatsuoka, the Japan Research Institute, Limited.

Tel: 03-3288-4263

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