German Optimism Falls as Europe Recession Risks Rise

By Fergal O'Brien

July 24 (Bloomberg) -- German business confidence plunged the most since the Sept. 11 terrorist attacks and European manufacturing and services shrank, increasing the risk of a recession across the euro region.

The Ifo institute's German business confidence index dropped 3.7 points from a month earlier to 97.5 in July. That was more than three times the decline forecast by economists in a Bloomberg News survey and the overall reading was the lowest in three years. Manufacturing and services across the euro area contracted for a second month and in the U.K., retail sales dropped by the most since at least 1986.

European executives are struggling to cope with surging oil prices, a stronger euro and a global slowdown sparked by the U.S. housing slump. With companies including Renault SA cutting jobs and the European Central Bank raising interest rates to fight inflation, more pain may be in store for consumers and companies.

``It may be premature to talk about recession in Europe, but the data does raise the risks,'' said Martin van Vliet, an economist at ING Group in Amsterdam. ``There's a toxic mix battering business sentiment.''

The decline in German confidence was part of a series of data today suggesting ECB President Jean-Claude Trichet may be too optimistic when he says growth will rebound later this year.

Confidence among Italian executives fell to the lowest since 2001 in July; French business sentiment was the weakest since May 2005; Spanish unemployment in the second quarter rose to the highest rate in 3 1/2 years; and Belgian business confidence this month dropped to the lowest since April.

No Immunity

European government bonds climbed after today's reports. The yield on the two-year note dropped 11 basis points to 4.46 percent and the yield on the 10-year bund, Europe's benchmark government security, slipped 6 basis points to 4.59 percent. The euro, which has increased 13 percent against the dollar in the past 12 months, fell as much as 0.4 percent to $1.5638 today.

``The abrupt falls recorded in the national business confidence indicators confirm that no country is immune to the slowdown,'' said Lavinia Santovetti, an economist at Lehman Brothers Holdings Inc.

Heidelberger Druckmaschinen AG, the world's largest printing-press maker, reported a first-quarter loss last week and said full-year sales and operating profit will decline. The company plans to cut 500 jobs.

Growth Trough

Beyond the euro area, U.K. retail sales fell 3.9 percent in June after rising 3.6 percent in May, which was the biggest increase since the data series began more than two decades ago. Economists forecast a 2.6 percent drop, the median of 30 estimates in a Bloomberg News survey showed.

Trichet said last week that Europe's economy will rebound after a ``trough'' in the second and third quarters and is refusing to give up his inflation-fighting rhetoric. At 4 percent, inflation is double the ECB's ceiling and the central bank earlier this month raised its key interest rate to a seven- year high of 4.25 percent.

``With just a bit of bad luck, any further monetary tightening could possibly push the euro zone into a brief recession,'' said Holger Schmieding, chief European economist at Bank of America in London.

While Europe may avoid its first outright recession in 15 years, economists say the ECB will have to revise its outlook for growth after its staff last month said expansion may ease to 1.5 percent in 2009 from an expected 1.8 percent this year.

Lower Forecast

``The ECB will have to acknowledge more clearly the economic downturn and will most likely trim its growth projection in September,'' said Lehman's Santovetti, who forecasts growth of 1.4 percent this year and 0.8 percent in 2009.

Crude oil, which has risen almost 70 percent in the last year, has dropped more than 10 percent this month and was at $124.15 a barrel today.

Measures of new business in Europe's manufacturing and services industry fell in July, a survey by Markit Economics showed today, while manufacturers' costs rose at the fastest pace in almost four years.

``The level of the surveys is not yet undershooting our forecast; we anticipate a stagnant GDP reading in the third quarter,'' said David Mackie, chief European economist at JPMorgan Chase & Co. in London. ``However, the rate of descent continues to suggest downside risk in the coming months.''

To contact the reporter on this story: Fergal O'Brien in Dublin at fobrien@bloomberg.net.