Global equity and commodity and euro zone debt markets are at risk of a sizeable correction. French and Dutch political uncertainty and a worsening European recession will feed global concerns about growth and debt. The deepest worry is that as Europe’s economy weakens, the uncertainty about how to address the crisis only increases.
The economic data is painfully clear. The first statistics of April suggest the euro zone recession which began in the fourth quarter has extended to the second quarter and is worsening. Service activity in France contracted sharply and firms cut jobs there and in Germany. That’s bad but the euro periphery is worse, with output falling faster – in the eleventh month of decline.
The big question is what to do. France encapsulates the debate. Francois Hollande’s strong showing in the first round of the presidential election is taken as a popular endorsement of pro-growth policies. But voters are rejecting ’austerity’ when little has arrived. France’s fiscal deficit was 5.2 percent of GDP in 2011 and its public debt to GDP ratio 85.8 percent. The OECD put French government spending at 56.2 percent of GDP in 2011 – well above the whole euro zone’s 49 percent.
The periphery’s plight is worse. Although recession in Italy, Spain, Portugal and Greece is set to be deep, pleas for less austerity seem certain to be rejected by Germany. That matters, because the periphery governments need Germany’s support to stay afloat. But the periphery’s crisis is not just fiscal – it is also one of competitiveness and growth. The easiest remedy may be a messy exit from the euro.
Euro zone fears seem set to rise again. The European Central Bank has flooded banks with cash and is ill-placed to intervene in the same way, though it ought to cut rates. A modest sell off seems likely in French debt and that of The Netherlands, as it faces an autumn election. The risks for Spanish and Italian debt are much greater.
The euro itself and global equity markets may well fall in sympathy. Oil and other commodities are vulnerable, too. Europe without a way forward may reverse an overly merry first quarter.