Eurozone fears and political instability send stock markets tumbling

Phillip Inman Economics correspondent

guardian.co.uk, Monday 23 April 2012 14.27 EDT

http://www.guardian.co.uk/business/2012/apr/23/eurozone-fears-stock-markets-tumbling

Fears of a long recession in the eurozone and increasing political instability in the Netherlands, France and the Czech Republic sent stock markets tumbling across the continent on Monday.

Weak manufacturing output across Europe and the fall of the Dutch coalition government combined to spooktraders, who sold the euro and continental shares in favour of safer US dollars.

The German Dax dropped more than 3.5% and the French Cac fell by 2.8%. In London £27.6bn was wiped from the value of the FTSE as it dropped nearly 2% to 5665.

The euro's poor performance, which also reflected the uncertainty surrounding the outcome of the French presidential election, left the currency trading at 81.5p against the pound.

"My fear at the moment is that [investors] appear to be panicking because the outcomes are getting more uncertain as we get further into this crisis – not less uncertain," said Paul Kavanagh, a partner at brokers Killik & Co.

The yield on Italy's benchmark 10-year bond pushed past 5.7% in the afternoon, extending the gap with German securities to 406 basis points. The Spanish 10-year yield was also unsustainably high after rising two basis points to 5.98%.

Analysts said an early look at economic surveys revealed that the European Central Bank's confidence-boosting injection of funds into the banking system had petered out and the eurozone was heading for a longer and deeper recession than expected.

The ECB has injected €350bn (£285bn) into the European banking system since December and played a part in constructing an €800bn firewall of guarantees and insurances to protect against Italy and Spain suffering a run on their debt. However, these two key measures are widely considered to be insufficient to boost confidence and revive the struggling economies of the worst-hit countries. Several European leaders have criticised the ECB for its failure to mimic the US Federal Reserve and the Bank of England, which have created electronic money under their quantitative easing programmes.

All the main parties in France, including President Nicolas Sarkozy's UMP, have shifted the blame for the eurozone's woes to the lack of decisive action from the central bank.

National Front leader Marine le Pen was particularly critical of the ECB and blamed the poor economic outlook on excessive austerity measures imposed by European institutions.

Figures from the combined purchasing managers' index (PMI) survey by Markit appeared to support these fears after they registered a weaker than expected composite PMI of 47.4 for the eurozone in April, consistent with a quarter-on-quarter contraction in GDP of about 0.3%. A figure of below 50 on the index denotes a contraction. The manufacturing index fell particularly sharply to 46 from 47.7, the weakest reading since mid-2009.

Services output remained stronger than manufacturing, but suffered a quicker slowdown. It fell to 47.9 from an earlier 49.2, the softest reading of activity since November last year.

Official statistics from Eurostat showing a rise in sovereign debts also added to the grim picture. Ireland's debts rose by 13.1% last year. Italy ended 2011 with the second highest debt at 120.1% of GDP, after Greece at 165.3%. Spain's rose to 68.5% from 61.2%. Germany was the only country to cut its lending, with its debt shrinking to 81.2% from 83%.

Across the 27-country EU, the average 2011 deficit was 4.5% of GDP, down from 6.5% in 2010. Among the EU states that do not use the euro, the UK had the highest deficit, which reached 8.4% of GDP in the year ended 31 March, equivalent to about 64% of GDP.

Only five eurozone nations – Estonia, Luxembourg, Slovenia, Slovakia and Finland – had debt within the eurozone's limit of 60% of GDP.

The head of the influential German Ifo thinktank raised the pressure on Greece and other countries. "I personally believe there's no chance for Greece to become competitive (while) in the eurozone," Hans-Werner Sinn, president of Ifo, said in a luncheon speech in New York. "If Greece is kept in the eurozone, there will be ongoing mass unemployment."

He also cited risks for other indebted eurozone countries. "Cutting wages and prices to the extent necessary in some southern European countries is impossible, whatever politicians say," Sinn said.

The region's overall budget deficit declined to 4.1% of GDP from 6.2% as nations from Greece to Spain and France implemented austerity measures aimed at stopping the spread of the debt crisis and convincing investors that Europe can shore up its public finances.

Jim Leaviss, head of the fund manager M&G's main bond fund, warned that the developments across the eurozone could pose problems for the UK. He said the slowdown in output on the continent and a rise in the value of sterling could act as a double whammy, threatening the UK's export drive. A higher value on sterling will push up the price of UK goods abroad, while shrinking markets in Italy and Spain will cut demand for British exports.

Leaviss said he calculated that a rise in the trade-weighted value of sterling since last year of 7.25% was equivalent to a significant monetary tightening by the Bank of England of 1.8%. Until now the BoE's quantitative easing programmehas offset any pressures on sterling's value. But the bank's interest rate-setting committee signalled last week that its QE programme would be halted indefinitely.

The only positive response to the rise in sterling will be a drop in inflation, he said, as imports to the UK become cheaper. "The strong pound will help send inflation below 3% during the course of the year, but at the expense of economic growth and a rebalancing of the economy towards manufacturing," he said.