Europe Confidence Drops as Financial Turmoil Worsens

By Fergal O'Brien

Sept. 24 (Bloomberg) -- Business confidence in the euro area's three largest economies declined more than forecast this month as the worsening financial crisis in the U.S. imperiled expansion around the world.

In Germany, Europe's biggest economy, the Munich-based Ifo institute's business climate index fell to a three-year low of 92.9 from 94.8 in August, below the 94.3 median forecast of 41 forecasts in a Bloomberg News survey. Business confidence in France declined to the weakest in five years, while sentiment in Italy dropped to a seven-year low, separate reports showed.

Europe's economy is struggling after shrinking in the second quarter as the yearlong credit squeeze leads to bankruptcy filings and bailouts on Wall Street and cooling economic growth damps demand. Even as expansion slows, the European Central Bank is resisting any cut in interest rates as it seeks to curb inflation that reached a 16-year high in July.

``Today's Ifo and yesterday's purchasing managers' index contradict any scenario of an imminent recovery in the euro-area business cycle,'' said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Plc in London. ``While the ECB will likely acknowledge the weaker growth trajectory at the next policy meeting, it is unlikely in our view to be a step toward an imminent rate cut.''

Below Forecasts

In France, the second-biggest euro-area economy, a gauge of business sentiment dropped to 92 this month from a revised 97 in August, below forecasts for a September reading of 97. Italy's business confidence index dropped to 82.7 from 83.5 last month. That is the lowest since October 2001 and less than the median forecast of 83.2.

Bonds rose after the reports, with the yield on the two- year German note dropping 11 basis points to 3.78 percent as of 12:10 p.m. in London. The yield on the 10-year German bund, the euro region's benchmark government debt security, declined 5 basis points to 4.18 percent.

The ECB on Sept. 4 kept its key rate at 4.25 percent for a second month, suggesting it's more concerned about faster inflation than slowing growth. ECB Governing Council member Axel Weber said yesterday that while the bank is aware there is a ``phase of weakening,'' slower growth ``won't magic away the inflation problem.''

Euro-area manufacturing and services contracted for a fourth month in September. The European Commission cut its euro- region growth forecast for this year on Sept. 10 to 1.3 percent from 1.7 percent and projected recessions in Germany and Spain.

Worsening Prospects

The cooling economy is taking its toll on companies. Fiat SpA, Italy's largest manufacturer, suffered a 23 percent decline in Italian car sales in August. German tire maker Continental AG cut its profit target for fiscal 2008 earlier this month, citing worsening prospects for sales and rising raw-material prices.

The economic outlook is ``clouded'' by the turmoil in financial markets, the European Forecasting Network said yesterday. In the U.S., Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Henry Paulson are pushing Congress to approve a $700 billion plan to remove illiquid assets from the banking system and calm a crisis that already has claimed Lehman Brothers Holdings Inc. and prompted U.S. authorities to bail out American International Group Inc.

Financial institutions worldwide have reported more than $520 billion in losses and writedowns since the lending crisis started. The Dow Jones Euro Stoxx 600 has shed more than a quarter of its value this year.

`Grave Mistake'

Paulson said yesterday it would be ``a grave mistake'' for Congress to delay or curtail the funds he requested to stabilize the financial system.

``The crisis is a reason for concern,'' said Andreas Scheuerle, an economist at Dekabank in Frankfurt. ``We're facing an extremely difficult time with growth rates around stagnation or possibly even worse.''

Companies may get some relief from the drop in the price of crude oil and the euro's decline against the dollar. Oil has fallen from a record close to $150 a barrel in July to around $109 today. The euro has dropped 7.8 percent from its July 15 record and was at $1.4660 today.

Lanxess AG, Germany's largest publicly traded specialty- chemicals maker, said on Sept. 17 it will meet its full-year profit goals as faster growth in Asian economies compensates for the U.S. slowdown. The third quarter is ``going well,'' Lanxess Chief Executive Officer Axel Heitmann said.

``Consumption is very weak and it will be getting worse over the coming quarters,'' said Paolo Pizzoli, an economist for ING Bank NV in Milan. ``The only hope is if oil stays around $100 a barrel, and that should give some relief. Still, with the financial crisis causing uncertainty, the future doesn't look good.''

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