Euro Area Suffers First Recession; Downturn May Turn `Deep'

By Fergal O'Brien and Simon Kennedy

Nov. 15 (Bloomberg) -- The European economy is down and may be out for some time.

After falling into its first recession since the introduction of the single currency almost a decade ago, economists at Bank of America Corp., Deutsche Bank AG and Citigroup Inc. say the euro-area economy will worsen in the current quarter and growth won't return until late 2009.

``The third quarter looks like a walk in the park compared to what lies ahead,'' said Thomas Mayer, chief European economist at Deutsche Bank in London. ``This will be a deep recession.''

The downturn leaves policy makers scrambling to limit its depth. The European Central Bank is set to cut interest rates again next month, having raised them as recently as July, while governments are lining up fiscal stimulus programs. Their efforts may come too late to prevent the recovery from lagging behind that of the U.S.

Gross domestic product in the 15 euro nations shrank 0.2 percent for the second straight quarter in the three months through September, the European Union's Luxembourg-based statistics office said yesterday. Germany, Ireland and Italy are now suffering a recession, while Spain's economy contracted for the first time in 15 years and the Netherlands and Portugal stagnated. The French economy unexpectedly expanded.

Multiple Shocks

Europe's economy is suffering from multiple shocks, including the euro's rise to a record $1.60 in mid-summer and oil's jump to an unprecedented $147 a barrel in July. The cost of credit then surged globally after the September collapse of Lehman Brothers Holdings Inc., forcing banks to cut lending to businesses and households and shattering demand for euro-area exports from the U.S. to Hungary.

The ECB last week lowered its benchmark rate by a half- point to 3.25 percent, the second such reduction in a month. As inflation ebbs, policy makers are now signaling further cuts when they meet in Frankfurt on Dec. 4.

Economists at Citigroup expect a reduction of at least 75 basis points next month, while those at JPMorgan Chase & Co. yesterday revised their forecast to show the main rate reaching 1 percent next year, the lowest since the ECB took the reins of monetary policy a decade ago.

The ECB is still moving too slowly and the recession proves the bank was wrong to raise rates in July, even though inflation was at its strongest in almost 16 years at the time, said Marco Annunziata, chief economist at Unicredit MIB in Milan.

`Painful Proof'

``We now have painful proof that there has been an excessive degree of complacency, which implies that the policy response in Europe is well behind the curve,'' he said.

ECB President Jean-Claude Trichet said in an interview with Bloomberg Television in Frankfurt yesterday that the central bank's ``considerable'' policy action, which extends to lending cash to banks, would help restore sentiment in the economy. ``Confidence will grow back,'' he said.

Governments that once bet their economy would avoid a recession are also looking to act although their ability to do so is limited by EU budget-deficit limits with Italy and France among those already running shortfalls. German Chancellor Angela Merkel said this week that she is considering boosting her 50 billion-euro ($63.3 billion) stimulus program.

Merkel and other leaders from the world's largest nations are meeting in Washington this weekend to discuss increased government spending and other ways to stop the rot. Retail sales in the U.S. dropped in October by the most on record as the economy headed for its worst slump in decades, data showed yesterday.

Sluggish Reaction

The sluggish reaction of European policy makers means growth won't return to the euro region until the final three months of next year, said Mayer at Deutsche Bank. That is two quarters later than what he expects in the U.S. where the Federal Reserve has already cut its benchmark interest rate to 1 percent.

``Policy in the euro area has been less flexible than in the U.S.,'' said Mayer. ``Things aren't going to get much better next year in Europe.''

Europe's downturn surprised even economists who in July saw just a 35 percent chance of a recession occurring in 2008, according to the median of 26 forecasts. Policy makers expressed confidence earlier in the year that the economy would dodge a recession even as the U.S. faltered. The European Commission began the year predicting growth of 1.5 percent in 2009, only to cut its forecast to just 0.1 percent as the financial crisis escalated.

The recession is the first in 15 years for the countries that use the euro and the fifth since the early 1970s, said Ben May, an economist at Capital Economics Ltd. The downturn of the early 1990s lasted four quarters, while the two of the 1980s lasted six months.

The broad decline across the region, its weaker potential growth rate in recent years and recessions elsewhere in the world mean ``it may be optimistic to expect a rapid pick-up in growth next year,'' May said.

To contact the reporters on this story: Fergal O'Brien in Dublin at fobrien@bloomberg.net; Simon Kennedy in Paris at Skennedy4@bloomberg.net.