Despite the Stock Rally, Europe Is Still Crying For Help

“Grappling with the aftermath of a profound financial and economic crisis, the EU economy is set to pick up speed only very slowly in the course of this year,” commented Marco Buti, Director General for Economic and Financial Affairs at the European Commission, in the organization’s spring economic forecast report. “After having turned positive in the second half of this year, real GDP growth is projected to gain traction in 2014 as investment and consumption are set to take over as the main growth engine.”

This relatively gloomy forecast is supported by a series of economic indicators released so far this year that paint a picture of a Europe that is not only still in contraction, but is sliding deeper into it. Eurostat, the statistical office of the EU, reported at the end of April that unemployment across the euro area increased to 12.1 percent in March, 1.1 percentage points higher than the year-ago period.

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A separate report showed that business investment fell to recent lows in the fourth quarter of 2012. Europeans have faced at least three years of severe debt crisis and five consecutive quarters of shrinking economic growth through the end of 2012, and Markit’s manufacturing PMI report showed that the downturn deepened at the beginning of the second quarter of 2013.

Annual GDP Growth EC

Source: European Commission

Data released on Monday added to the growing body of bad news for the European economy. The Economic Sentiment Indicator, compiled by the European Commission, decreased by 1.5 points in the EA17, and decreased by 1.8 points in the EU27, trending well below the long-term average.

European Economic Sentiment

Source: European Commission services

Perhaps most troubling is that economic sentiment worsened significantly in major economies such as Germany (-2.3 points), France (-2.0 points), and Italy (-1.9 points). Overall, the index dropped to 88.6, which compares against the long-term average set to 100. The decline was more than expected, with economists polled by Bloomberg forecasting a decline to 89.3.

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Chris Williamson, chief economist at Markit, which complies PMI reports for the euro zone, commented that “although the PMI was unchanged in April, the survey is signalling a worrying weakness in the economy at the start of the second quarter, with signs that the downturn is more likely to intensify further in coming months rather than ease.”

“Domestic demand is expected to remain constrained by a number of growth impediments commonly associated with balance-sheet recessions after deep financial crises,” continued Buti, Director General at the European Commission.

Because of this weak domestic demand, the European economy will depend on foreign demand for growth. China, the United States, and Japan are all expected to log positive GDP growth figures for 2013 and 2014, which throws some optimism into the mix, but each nation is facing its own series of economic problems.

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Trying to address its own, the European Central Bank announced this week that it will lower the interest rate on both the marginal lending facility and main refinancing operations within the Eurosystem. Effective May 8, the rate on the marginal lending facility will be decreased by 50 basis points to 1.0 percent, and the rate on main refinancing operations will be decreased by 25 basis points to 0.50 percent. The interest rate on the deposit facility will remain unchanged at 0.0 percent.

“Despite the accomodative stance of monetary policy and low average financing costs in the EU, the debt overhang from the crisis has reduced credit growth,” commented Buti. “In the short run, private investment and consumption are also being held back by uncertainty about the economic outlook, while the weakness of the labour market will continue to weigh on domestic demand going forward.”

Eurozone Unemployment by Region

Source: Eurostat

Despite all these concerns, European equities rallied on Friday, pressing for five-year highs and extending gains made largely on the assumption of increased action from the ECB. Germany’s DAX climbed as much as 2 percent on Friday, while the STOXX 50 index of Blue-chip companies climbed 1.65 percent.

European equities chased U.S. markets that shot up following a positive labor market report. However, it’s important to keep in mind that despite all of this cheer in the stock market, severe austerity measures implemented across Europe continue to negatively impact the lives of millions of people.

On May 1, thousands of people took to the streets all across Europe to protest those austerity measures. These policies were meant to curb deficits and reduce overall debt, and ostensibly stabilized national economies before they collapsed, but many feel that they have done more harm than good. The evidence for this rests in the still-slow or negative economic growth and record unemployment.

Critics of austerity champion a program that focuses on growth, and growth means spending. The thinking — currently being debated at the top levels of government, academia, and finance — is that the short-term damage caused by austerity would linger painfully in mid- and long-term recovery efforts. Spending, on the other hand, can be accommodated more comfortably, even at debt loads near or above 100 percent of gross domestic product.

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