Special

Eurozone, skidding recession?

Financial Markets Research
30 August 2011

www.rabotransact.com

Elwin de Groot +31 30 216 9012

Figure 1 Economic surprise index1 pointing to slowing growth into Q3

4 3 2 1 0 -1 -2 -3 -4 -5 -6 04 05 06 07 08 09 10 11 EZ surprise index (z-value) GDP growth %YoY 4 3 2 1 0 -1 -2 -3 -4 -5 -6

Figure 2 Our model signals elevated recession risk in eurozone...

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

Source: Reuters EcoWin, Rabobank

Source: Reuters EcoWin, Rabobank

1) Our eurozone economic surprise index is calculated on the basis of 80 monthly indicators from Germany, France, Italy and the eurozone as a whole. It is calculated by taking the deviation from each monthly series from its 1-month ahead expected value, the latter being determined by a simple time-series model. The overall index is a simple average of these indicators.

Elevated recession risk in the eurozone...

Since Q2, a range of macroeconomic indicators has deteriorated, pointing at slowing growth. Our eurozone economic surprise index fell to -1.7 in June1. Although the preliminary index has recovered slightly in July and August, it has remained firmly below the zero-mark thus emphasising the negative trend (Figure 1). Note that particularly for August this index is calculated from a much smaller sample. If the sharp falls in the Ifo business climate index and ZEW survey for August are repeated in other indicators, we are likely to see downward revisions to this index. What stands out from the data we have so far is the relative swiftness with which indicators have deteriorated, much less their actual levels. The PMI surveys are a case in point. The composite eurozone PMI stood at 51.1 in August. That is not even close to signalling a contraction, but it has fallen by nearly 7 points over the space of four months time, which brings back memories of those dark days following the Lehman collapse. Against the backdrop of the ongoing sovereign debt turmoil in the eurozone, the markets fear that a double-dip recession is already underway, is understandable. After all, the economic recovery following the global recession has not been exciting to begin with, and households who have barely been able to repair balance sheets remain vulnerable in the face of austerity measures. To estimate the near-term risk of recession, we have updated our recession-probability model. The model is based on the relationship between the occurrence of past eurozone recession periods (as identified by ourselves) and a selected set of monthly indicators, such as retail sales, PMI, industrial production, consumer confidence and unemployment. On the basis of currently available data, the model suggests that recession risk has been rising sharply since May and is now close to 60% (see Figure 2).

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Eurozone, skidding recession?

30 August

www.rabotransact.com

Figure 4 ...But accommodative monetary policy remains a powerful counter-force...

-1 1 3 5 7 9

Figure 4 ... and European companies are in good shape and cash-rich

4 2
Percent

0 -2 -4 -6 88 90 92 94 96 98 00 02 04 06 08 10 12 Eurozone - GDP SA Constant Prices 3M Euribor -/- core inflation rate (1 year lagged)

Source: Rabobank EZ Recession Probability Model

Source: Bloomberg, Rabobank calculations2

2) Based on a sample of 300 largest European listed non-financial companies

... But monetary policy still accommodative

However, whether this recession risk materializes depends, at least partly, on the size of potential feed-back effects from recent market ructions. At the current juncture, we feel the economy could still skim over recession, but it will be a close-call. Of note is that past recessions have frequently been the result of central banks hitting the brakes (often following a rise in inflation). That is obviously not the case this time around, with real money market rates having remained close to zero over the past two years (Figure 3). Moreover, (large) companies are generally in a better position to withstand shocks, being cash rich and having seen a sharp recovery in profits since the recession of 2008/09 (Figure 4.) Our basis scenario, then, is that GDP growth will slow to close to zero in coming months (with a distinct possibility of one quarter of negative growth), but will pick up again by early 2012. On average, GDP may expand by 1-1.5% in 2012. Even so, that is not much to be cheering about and it would likely force the ECB to keep rates on hold for an extended period.

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Index (billions)

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