Europe Probably Entered First Recession in 15 Years

By Fergal O'Brien and Simon Kennedy

Nov. 14 (Bloomberg) -- Europe's economy probably fell into its first recession in 15 years in the third quarter, paving the way for deeper cuts to interest rates and taxes amid the worst financial crisis since the Great Depression.

Gross domestic product in the 15 euro nations shrank 0.2 percent in the third quarter from the previous three months, when it also contracted 0.2 percent, according to the median estimate of 39 economists in a Bloomberg News survey. The two quarters of contraction -- the result of this year's surges in the cost of credit, the euro and oil prices -- would mark the first recession since the single currency was introduced almost a decade ago.

Consumers and companies are feeling the pain as sales, profits and hiring deteriorate, forcing the European Central Bank to embark on the fastest round of rate cuts in its history and governments to line up fiscal-stimulus programs. The slump may prove longer-lasting than those in the U.S. and Asia, with Bank of America Corp. and Deutsche Bank AG predicting Europe's economy to shrink in 2009 and no return to growth until late next year.

``We're in for a pronounced downturn in Europe,'' said Paul Donovan, an economist at UBS AG in London. ``It's going to be at least two years of very weak growth.''

The European Union's Luxembourg-based statistics office is scheduled to publish the euro-area GDP data at 11 a.m. today.

French Surprise

The German economy, Europe's largest, contracted by a bigger-than-expected 0.5 percent in the third quarter, confirming it has entered its worst recession in at least 12 years, its government said yesterday. Spain's economy contracted for the first time in 15 years, data today showed, while a separate survey of economists estimates that Italy also shrank.

Bucking the trend, French GDP unexpectedly expanded 0.1 percent from the second quarter, when it shrank 0.3 percent. Economists had forecast a contraction of 0.1 percent.

Europe's downturn surprised 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.

Earnings Decline

The economy is suffering from multiple shocks, including the euro's rise to a record $1.60 in mid-summer, the strongest inflation in almost 16 years 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 America to Hungary.

Holcim Ltd., the world's second-biggest cement maker, on Nov. 12 said it would shut a factory in Spain as earnings decline. German chemicals supplier BASF SE and French tire maker Michelin & Cie. are also cutting output and jobs. CRH Plc, the world's second-largest building-materials supplier, this week cut its target for full-year earnings after weaker-than-expected sales in Europe.

``The financial crisis has arrived in the real economy,'' BASF Chief Executive Officer Juergen Hambrecht said Oct. 30. ``It all has some kind of a flavor of a recessionary development.''

Worst Slump

Other major economies may not be far behind the euro region as the International Monetary Fund predicts the worst global slump in almost three decades. The U.S. economy, the world's largest, contracted 0.1 percent in the third quarter, after a fiscal stimulus package boosted it by 0.7 percent in the previous three months. The U.K. economy shrank 0.5 percent, marking the first decline in 16 years.

The ECB last week lowered its benchmark rate by a half- point to 3.25 percent, the second such reduction within a month. Having raised rates as recently as July to combat inflation, policy makers are now signaling further cuts.

The euro region is already ``in recession,'' ECB council member Ewald Nowotny said yesterday in Brussels. ``Inflation expectations should come down fast and that will give the ECB room for additional expansionary measures.''

Investors expect the ECB will lower its key rate by at least another half a percentage point at its next meeting on Dec. 4, Eonia forward contracts show. Economists at Fortis and Morgan Stanley this week revised their outlooks to show the ECB cutting to 2 percent next year, while those at Deutsche Bank expect 1.5 percent to be reached for the first time.

Some Strength

While the recent decline of the euro against the dollar and a halving in the price of oil from its peak may provide some strength to the economy, analysts warn the recession may persist for longer in Europe than in the U.S. because its policy makers have been slower to act than counterparts in Washington.

Thomas Mayer, chief European economist at Deutsche Bank, calls the ECB's July rate increase a ``mistake'' and estimates the region's fiscal easing will be half that of the U.S. He predicts expansion in the U.S. will resume in the second quarter of 2009 and not until the final three months of the year in the euro region.

Recovery may also be delayed by debt-laden companies and labor laws that make it hard for payrolls to be cut. With its benchmark rate now the highest among the Group of Seven nations, inflation may still not retreat fast enough for the ECB, which seeks to keep it just below 2 percent. Competition among businesses is weaker than elsewhere and employers have less flexibility on wages because of regulations that set minimum levels or tie worker pay to past inflation rates.

First Test

Governments also are looking to protect their economies and support among voters. German Chancellor Angela Merkel said this week she may expand her fiscal stimulus program from the 50 billion-euro ($62.6 billion) package endorsed by her Cabinet last week. She and other leaders from the Group of 20 economies today begin crisis talks in Washington.

The response of governments may mark the first test of 2005 revisions to the Stability and Growth Pact, which caps deficits to 3 percent of GDP unless growth undershoots forecasts. EU Monetary Affairs Commissioner Joaquin Almunia said Nov. 4 that ``we agree on the need to use the flexibility'' contained in the revised pact.

``Monetary policy is not as effective as in previous crises and that brings us to fiscal policy,'' said Carsten Brzeski, an economist at ING Group in Belgium. ``We might see a 180-degree turn in Europe's approach on using fiscal policy if it's the last rescue anchor for the economy.''

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