The credit crunch could crush the euro
By Liam Halligan, Economics EditorLast Updated: 12:37am GMT 03/12/2007
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The credit crunch is hammering the US, which now faces a likely
recession. Things don’t look great for the UK either; here growth
could plunge to 1 per cent next year.
News
and analysis on the credit crisis
There is a near-consensus among economists, in fact, that the
Anglo-Saxon world created this credit crunch and will likely bear
the most pain.
The eurozone, it is widely assumed, has been less affected by
sub-prime. Most investment banks predict the 13-country region will
out-perform the UK in 2008.
A slew of recent data tells me we should now question that
assumption. If I’m right, and the eurozone does a face serious drop,
us Brits would be foolish to grin. We like to revel in Continental
misfortunes, but the single currency area matters hugely –
accounting for three-fifths of UK trade, more than four times as
much as the States.
The reason the eurozone now worries me is the emerging picture of
sharply rising consumer prices on the one hand, and falling output
on the other. Just like the Bank of England, the European Central
Bank will on Thursday try to set monetary policy not only to deal
with inflation, but also bolster growth.
Eurozone base rates are likely to be held at 4 per cent – for the
sixth month in a row. Most observers think if they do shift this
week, the only possible move is up.
That’s because, despite the credit crunch, the ECB’s rhetoric has
remained very hawkish. But, in reality, eurozone policy makers now
face a classic growth-inflation dilemma – one they share with other
Western central banks.
The ECB’s predicament is made worse, though, by the euro/dollar
exchange rate, and the single currency’s structural flaws. These two
unique aspects of the region’s quandary are why its prospects are
more gloomy than assumed.
Evidence that eurozone growth is souring is now coming thick and
fast. In Germany, the region’s powerhouse, retail sales fell 3.3 per
cent between September and October we learnt last week – with
consumer spending frail in many other member states too. Europe’s
bellwether Economic Sentiment Indicator also fell for the sixth
consecutive month.
With weakening global demand slowing industrial growth, the
eurozone’s crucial manufacturing sector is starting to suffer as
well. The closely-watched IFO index of German business sentiment is
well below its December peak. Europe’s PMI industrial index has also
dropped close to 50 – a value which, in previous years, has provoked
interest rate cuts.
But the ECB will have a big problem lowering rates this Thursday
– or anytime soon – because eurozone inflation jumped to 3 per cent
in November, up from 2.6 per cent the month before. Inflation has
almost doubled since the summer – with rising oil and food costs
causing consumer prices to balloon.
Germany’s CPI grew 3.3 per cent last month – a 13-year high. And
price pressures elsewhere mean eurozone inflation will stay above
the ECB’s 2 per cent target for months to come.
Then, of course, there’s the US currency – that is, the impact of
the feeble greenback on the euro. Over the last year, the single
currency has risen more than 15 per cent against the dollar, which
has seen investors dump US assets. This makes European leaders see
red, of course, as a rising currency undermines exports and jobs.
Some say such protests are overdone. After all, a stronger euro
dulls the impact of more expensive oil. Dollar oil prices have risen
90 per cent since January, compared with 60 per cent in euros.
The eurozone also sends less than a tenth of its exports to the
US. So, on a trade-weighted basis, the euro is up only 7 per cent
against the dollar since January – less than half the straight
euro-dollar rise.
Have your say
Comments
To me it was always a question of "when" not "if" the Euro collapsed. I gave it ten years when it started. I don't think that will be far wrong. My only other hope is that the UK isn't affected too badly when the euro collapse precipitates the collapse of the whole EU political empire. And good riddance!
Posted by Cllr Chris Cooke on December 2, 2007 3:08 PM
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I hope this brings a crashing end to the Euro and the evil undemocratic empire which I have never been given a vote on. RIP EU
Posted by delboy on December 2, 2007 3:00 PM
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One major problem for the EU is aerospace, where Airbus priced its products in dollars when it began to capture part of the commercial market.
That was fine in the pre-euro days but now that the dollar has fallen behind the euro it places great strain on Airbus.
Given the EU cost of production selling in dollars makes for large losses. So how will the EU respond?
Posted by Brian Wilson on December 2, 2007 2:26 PM
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Just remember that Gordon Brown took all the credit for economic growth over the 10 years - despite most of it caused by a) debt and b) benign economic conditions elsewhere.
Be sure to castigate him therefore all the time for the recession/ bankruptcies, increase in jobs - even if most of them are caused by factors out of his control.
Be sure that I will.
Posted by John Portwood on December 2, 2007 2:20 PM
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Let's not get too carried away.
Whilst the single currency area does account for
approximately 60% of UK trade, this really needs
to be set in context. This statistic simply
represents the % of total export trade.
However about 80% of the UK's economic effort
in GDP terms is internal to the UK, with exports
accounting for the 20% balance.
In other words for most businesses the single
currency area is irrelevant, and the "60%" EU
exports represent only 12% of GDP.
Posted by Richard on December 2, 2007 2:05 PM
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The point about the Euro is that the top politicians in the largest and most successful countries in Europe have placed their reputations behind the wobbly edifice.
The whole thing seems completely implausible from an economic point of view (Italy, Portugal etc desperately needing to devalue vs Germany) but the top Europeans are not stupid.
They will find a way for occasional step adjustments to occur, such that the more absurd aspects of the system are avoided.
That will of course blur the federal message, but the other option is a currency bust-up with perhaps a German-centered nucleus remaining with the less disciplined cast free to find their own levels.
Without the adjustment mechanism, Spain looks especially vulnerable - new Peseta anyone?
This is what happens when political desire preceeds economic reality.
As for the USA, they are not daft, either. By devaluing their currency they push the balance of payments problem elsewhere, though at the expense of higher oil import costs.
The US economy will be fine in a couple of years, but how about Europe?
Posted by Colin on December 2, 2007 2:03 PM
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As per usual the talking heads in suits totally avoid the cause of the problem.
The problem is not that inflation is rising here or there, or the EURO or any of the other things that this particular talking head mentions, the problem is the money system.
It has got to go and it will take along with, hopefully, all the talking heads who earn their living by talking it up.
There is no way that a serious financial collapse can be avoided in the coming years. The level of debt is just too high and increasing every day despite the write offs.
It may not happen yet. Indeed, the fact that the FED is considering reducing interest rates despite a falling dollar and rising inflation (more like 10%) shows that it is really concerned in protecting its owners, the banks.
Posted by Alan Heaton on December 2, 2007 1:04 PM
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The oil price is now 'trending' down. Let's just hope there are no poblems with supplies or increased demand. We don't need a price surge now.
Posted by John on December 2, 2007 12:56 PM
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nic (10.27am) - be careful what you wish for.
It would have been better to have avoided the boom in the first place, but all those who are now looking forward with glee to a big fall in prices to help buyers get on the property ladder are likely to be disappointed.
HSBC last week predicted 30% to 40% fall in house prices. A fall of that magnitude, coupled with imported inflation due to the combination of commodities AND a falling pound, will so damage the UK economy that prospective house buyers will find themselves in a new predicament.
Posted by MarkS on December 2, 2007 12:37 PM
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Forget the CPI and the RPIX, the only true measure is the RPI and this is being depressed by the Chinese and other far east countries.
When they raise their prices inflation will take off. Domestic inflation is far greater that the depressed index reveals.
These far-east countries do not have the excessive tax burdens we have been imposed with.
Posted by John Chambers on December 2, 2007 12:18 PM
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King is correct.
This problem was caused by by too low interest rates for too long encouraged by a financial indicator the CPI (imposed on the BOE) which did'nt include housing costs.
Forget about the CPI instead look at the RPI and the previous indicator the RPIX.
Inflation is here; to cut interest rates before bringing RPI under control is inviting an even bigger problem for the Prime Minister in the future as inflation spirals out of control.
In any event since the CPI does not include housing costs why should housing on the way down influence interest rates since it did'nt influence them on the way up.
Posted by James on December 2, 2007 12:06 PM
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"Could it happen? Why not? Every other currency union in the history of man has broken up – unless, like the US and UK, it has been preceded by generations of political union, and held together with a federal tax system."
As soon as the EU constitution is ratified you will see a swift move to a federal tax system.
The euro has been under strain since its inception.
Italy, who always relied on devaluing its currency to reduce its debt has big problems.
I believe it will be a race between having a federal tax system and the euro folding.
Posted by Bertie Poole on December 2, 2007 11:55 AM
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For 20 years we have printed money and given it to China, India et al to purchase cheap goods.
Why are we suprised that they are now spending this money and pushing up the price of oil, raw materials and food.
Putting up interest rates here won't put a lid on demand in other countries. The western world will just have to swallow this bought of inflation.
Posted by Steve Byrne on December 2, 2007 10:37 AM
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Why do you say there are fears that the housing market is turning? Fears by whom? Presumably vested interests.
It is turning and a good thing too. Do we expect,or want house prices to rise forever? Do we want our children to live in rabbit hutches,living and earning simply to pay off a large loan.
The BofE and the government have been very irresponsible over many years in allowing such low interest rates, based on manipulated inflation data, and indecently high levels of borrowing.
They have lost touch with reality.
It must stop!
Posted by nic on December 2, 2007 10:27 AM
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Obviously we are due a full scale recession in 2008.
First HOUSING finds gravity. Depending on CHINA/Middle east countries investment decisions; our destiny is now out of our control.
The next two years will see the biggest changes ever experienced in the world economy. America will probably pull through... but only just. Its too big to fail.
The same can't be said for BRITAIN. The longer US/UK stay in Iraq the worse the oil price gets.......at the end of the day oil will be deciding factor.
World inflation is arriving with a vengence...hold cash!
Posted by richard bond on December 2, 2007 8:57 AM
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