24 August 2011 Economics Research

http://www.credit-suisse.com/researchandanalytics

European Economics
Research Analysts Christel Aranda-Hassel +44 20 7888 1383 christel.aranda-hassel@credit-suisse.com Violante Di Canossa +44 20 7883 4192 violante.dicanossa@credit-suisse.com Neville Hill +44 20 7888 1334 neville.hill@credit-suisse.com Axel Lang +44 20 7883 3738 axel.lang@credit-suisse.com Giovanni Zanni +33 1 7039 0132 giovanni.zanni@credit-suisse.com

Double whammy
We have cut our growth forecasts for this year and next. We now expect euro area GDP to grow by 1.7% in 2011 and 1.0% in 2012. UK GDP should grow 1.0% this year and 1.5% next. We expect both the ECB and BoE to keep rates on hold. It is now clear that the political uncertainty and financial turbulence of the past two months has had a negative impact on business confidence and activity in Europe. The latest round of business surveys generally show a precipitous fall in business confidence and, to a lesser degree for now, activity. For a recovery predominantly driven by business spending, such a confidence shock is likely to mean weaker growth. And we now expect output growth in both the euro area and UK to be more or less flat in H2 this year. These economies are likely to skirt recession and in the absence of a new shock: probability models suggest the chances of recession in Europe are around 40%, but those chances have risen sharply in the past few weeks. However, we expect this to be a brief pause in recovery in our central scenario, rather than a relapse back deep into recession. The financial and economic health of the corporate sector makes the prospect of deep cuts in output unlikely. However, there are considerable risks to this forecast. The biggest downside risk would be another disruptive financial shock. Unfortunately, the continued euro area government debt crisis, particularly renewed uncertainty over the Greek rescue package, provides a potential source of such a shock. And the euro areas fiscal problems mean any re-acceleration in growth in early 2012 is likely to be subdued. Despite the likelihood that growth this year and next will be lower than governments expect, we think they will continue to meet their deficit projections for 2012. But further, pro-cyclical, fiscal tightening will be needed to achieve that, which will prove an additional headwind to growth early next year. Economies without the need (Germany) or pressure (UK) to tighten policy further are likely to see a more lively rebound, in our view. In all, that means weve cut our forecasts for growth for this year and next, and now look for the euro area to grow by 1.0% and the UK by 1.5% in 2012. A prolonged period of weak growth should keep the central banks from tightening from here. But unless these economies sink back into recession, or there is a substantial financial accident, we dont anticipate any easing in monetary policy.
*The authors of this report wish to acknowledge the contribution made by Maxine Koster of Koster Economics Limited.

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