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European Austerity Measures Risk Stymying Growth Possibilities [LIVE UPDATES]

Europe Austerity

First Posted: 12/14/11 09:20 AM ET Updated: 12/14/11 10:10 AM ET

(Carmel Crimmins and Gavin Jones) - Europe's "no pain no gain" attitude to solving its sovereign crisis risks exacerbating the bloc's problems, choking off the very growth needed to raise the money to pay down the debt.

From Athens to Dublin, and almost everywhere in between, administrations are imposing wave after wave of spending cuts and tax increases to persuade investors they are serious about improving their public finances and persuade them to start buying euro zone sovereign debt again.

The austerity zeal risks tipping the continent back into recession and a downward spiral of austerity as pitiful growth prospects undermine budgetary targets and ramp up debt burdens, meaning further austerity is required.

"The expansionary fiscal contraction story says that you cut, you show you are serious about cutting and then the confidence fairy will come along and she will start pulling in private investment," said Stephen Kinsella, professor of economics at the University of Limerick.

"The expansionary fiscal contraction story is a lie. You don't cut your way to growth."

With the crisis spreading like wildfire through the currency bloc's core, pushing up borrowing costs to unsustainable levels, countries are relying more on blunt budget cuts, than time-consuming and difficult structural reforms, to get results.

The upshot is ballooning dole queues, shuttered businesses and public services stretched to breaking point.

On the streets of Athens and Dublin poverty has visibly increased with more and more homeless people huddling in doorways. In Spain, emergency wards have been shut and in Italy, retailers are struggling to get by.

"Consumption has been falling pretty steadily since the winter of 2008. Normally in a crisis, it starts with menswear and goes to womenswear and children. This time, it's hit them all at once," said Attilio Lebole, head of Textura, a mid-range clothing wholesaler based in Florence.

"Demand is falling, there's no doubt about that. Only foreigners are still shopping."

Despite having an estimated budget deficit this year of 3.8 percent of GDP, below the European average of four percent, Italy has been piling on austerity since the summer, destroying its already poor growth prospects and then responding with still more austerity to make up for the weaker growth.

Italy's dismal growth prospects and an inability to pass growth-enhancing reforms have been the key reasons given by ratings agencies for downgrading the country, not deficit slippage.

"Italy is paying a very high price for lending credibility to Germany's push for greater fiscal discipline across the eurozone," said Nicholas Spiro, head of Spiro Sovereign Strategy.


In the pre-euro days, currency devaluation was the quick-fire route to getting overblown economies back on track. What's needed now is "internal devaluation" to get wages and domestic prices down. But if everyone is cutting back where will the demand come from?

Global growth was meant to be the secret ingredient that kept the Irish economy ticking over while it slashed household income -- down by an estimated 16 percent so far and counting -- but the spread of austerity measures across the euro zone has shrunk its growth prospects and forced Dublin to cut even harder.

Held up as a role model for other indebted nations, the irony is that Ireland's recovery story looks set to be tripped up as others follow suit.

In Spain, the incoming government is hoping that changes to a labor laws, which would untie wages from inflation, as well as measures to aid new businesses would help spur growth despite painful cutbacks.

But analysts are unconvinced and say inevitable austerity measures needed to make tough public deficit targets in 2012 will serve to trim growth even further.

A Reuters poll on November 24 showed the economy not growing at all in 2012. Others like savings bank foundation FUNCAS predict the economy will contract 0.5 percent next year as a result of the impending austerity measures.

"The deficit objectives are so tough that in the short-term it's not going to allow the government room to stimulate the economy or create jobs. There is no fiscal margin to do so," said Angel Laborda, head of research at FUNCAS.

Across the euro zone, retailers are bracing themselves for yet another drop in Christmas cheer as sales taxes are hiked in Italy, Greece and Ireland.

The Greek Commerce Confederation (ESEE) is predicting a 22 to 30 percent fall in retail sales, with per capita spending seen dropping to 288 euros from 410 last year and 550 euros in 2009.

And the New Year isn't looking much better. Last week's European summit laid out plans for balanced budgets implying austerity budgets for years ahead for many European states.

Hilary Behan has already closed three of her six children's clothes stores in Ireland, cut her staff from 38 to 20 and asked her store managers to take pay cuts of between 10 and 15 percent. Sales are down by over a third since 2008.

"It just keeps getting worse and that's the worrying thing there is no sign of any recovery. Every time the government get a chance they remove any chance of there being any sort of a recovery," she said.

"It's not even the amount of money that they are taking from people it's the constant battering. People are terrified to spend."

(Additional reporting by Giulio Piovaccari in Rome, George Georgiopoulos in Athens and Nigel Davies in Madrid. Editing by Jeremy Gaunt.)

Copyright 2011 Thomson Reuters. Click for Restrictions.

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Mariano Rajoy, who will be sworn in as prime minister of Spain on Wednesday, has lain out some of the measures his government intends to take to address Spain's looming budget deficit.

Rajoy told members of Parliament Monday that his government will pass a provisional 2012 budget by the end of December, according to the Financial Times.

Under Rajoy's plan, public sector hiring is expected to drop off sharply, and all forms of public spending except pensions will be vulnerable to cuts, the FT reports. The proposed budget aims to reduce Spain's deficit by €16.5 billion, according to BBC News.

Spain has an unemployment rate of nearly 23 percent, the highest of any developed economy. Rajoy told Parliament that measures to reform the labor market would be devised by the end of March.

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The credit ratings agency Fitch Ratings just downgraded five major European banks and banking groups: Credit Agricole in France, Rabobank Group in the Netherlands, Danske Bank in Denmark, OP Pohjola Group in Finland, and Banque Federative du Credit Mutuel in France.

From the press release:

The downgrades reflect the broader phenomenon of stronger headwinds facing the banking industry as a whole. Exposure to troubled Eurozone countries through their subsidiaries was a direct consideration in the downgrades of Danske Bank and Credit Agricole. For the other banks, however, Fitch considers the Eurozone crisis is also having negative indirect consequences. Capital markets, in particular interbank markets, are not functioning effectively, and, along with more global factors, the crisis is driving economic slowdown.

--Bonnie Kavoussi

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Fast-growing populist parties across Europe are ramping up their protests against ruling governments in response to last week's European summit deal to implement stricter rules to prevent European countries from spending more than allowed, according to The Financial Times.

From The Financial Times:

The trend made its most high-profile intrusion yet in Italy on Wednesday, when senators from the anti-EU Northern League heckled and jeered Mario Monti, the technocratic prime minister, as he was presenting his austerity programme.

The Northern League outburst came as populist leaders in Finland, Hungary and the Netherlands have also renewed attacks on government leaders. Several denounced a proposed intergovernmental treaty agreed at the summit on Friday, which would strictly limit spending in signatory countries.

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German Chancellor Angela Merkel's cabinet agreed on Wednesday to reinstate Germany's state bailout fund, paving the way for Commerzbank, Germany's second largest bank, to receive a government rescue, according to The Financial Times.

From The Financial Times:

Officials in Berlin are privately sceptical that Commerzbank can keep to its pledge to shore up its capital without using more state funds. The bank received more than €18bn of aid during the financial crisis and remains 25 per cent state-owned.

Commerzbank was one of the biggest losers when the European Banking Authority this month published updated results of stress tests of European banks along with orders to plug any capital needs. Commerzbank, which owns €13bn of the peripheral eurozone debt at the heart of the continent’s fiscal crisis, saw its capital gap balloon from €2.9bn to €5.3bn because of the debt exposure.

--Bonnie Kavoussi

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Credit Agricole, France's third largest bank, announced on Wednesday that it would slash 2,350 jobs and not give stockholders a 2011 dividend, according to The Financial Times.

The bank also plans to deleverage its activities, cut bank its consumer finance unit, and desert operations in 21 countries, according to the FT.

European banks provide substantial financing to emerging economies in Latin America and Asia, according to some economists, so the retrenching of European banks is likely to be a double-whammy for the American economy: both by tightening credit in the United States and by hurting demand for American exports as businesses in emerging economies have trouble finding financing.

--Bonnie Kavoussi

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European markets have taken something of a battering today, with all the major indices posting substantial losses. The euro fell to an 11-month low and Italy saw its 5-year bond yields rise to a euro-era high at an auction in the morning.

At the root of much of the turnaround in sentiment is renewed opposition to the use of the European Central Bank's "bazooka" to buy up European debt, or to inject money into the International Monetary Fund (IMF) for the same purpose.

The German DAX and French CAC-40 fell 1.6% and 3%, respectively, while the FTSE-100 was down more than 2% on a combination of domestic and European economic worries.

--Peter Guest

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Angela Merkel has said that she regrets that the UK is not involved in the newly negotiated treaty within the EU, but has reiterated that Britain remains an important partner to the EU and to Germany.

Speaking in the Bundestag, the German chancellor said it was regrettable that Britain was not part of the process, agreed in frantic talks last week, that pledged to create enforceable fiscal rules within the eurozone and to move towards greater economic integration.

But she added: "I have no doubt that in the future Britain will also be an important partner in the European Union.

"Britain is not only an important partner in foreign and security affairs. Britain is a partner in many other areas - in competitiveness, in the internal market, in trade, in [fighting] climate change."

The UK is the only country out of the 27 EU member states that is not part of a plan to better integrate the union's economies. Prime Minister David Cameron's decision to pull out of talks led to fears that Britain could become isolated from the EU, its largest trading partner.

--Peter Guest

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Germany, Europe's largest economy, will not be immune from the economic downturn plaguing Europe. The University of Munich's Ifo Institute forecasts that the German economy will grow just 0.4 percent next year -- much less than the 2.3 percent growth originally forecast in June, according to Dow Jones Newswires.

"The debt crisis is slowing down the German economy," the Ifo Institute said in the report.

--Bonnie Kavoussi

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The leader of Germany's liberal Free Democratic party unexpectedly resigned on Wednesday, highlighting the disorganization of the party, a junior partner in Angela Merkel's ruling coalition, as it struggles to define its eurozone policies, according to The Financial Times.

Christian Lindner, the party's chief manager, resigned without giving a clear explanation.

From The Financial Times:

The resignation confirms the perception of the FDP as a party without clear leadership or direction, undermining the coherence of the Merkel government and making all forms of decision-making in the coalition more complicated.

--Bonnie Kavoussi

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The European Central Bank needs to guarantee the maturing government debt of countries such as Italy and Spain so that their borrowing costs can fall back to a sustainable rate of about 4 percent, hedge fund manager John Paulson wrote in an op-ed in The Financial Times on Wednesday. Paulson is known for earning more than $15 billion for his firm by betting heavily against the housing market before the housing bubble burst.

In return, the ECB could collect a one percent annual guarantee fee, and it most likely never would have to act on the guarantee, so it would not cause inflation, Paulson wrote.

From the op-ed:

The benefits to this programme are many: it would immediately stabilise the sovereign credit market, it would not expand the ECB’s balance sheet, it would not cause inflation, it would keep interest costs low, and negate the need for the ECB to buy debt in the primary or secondary market. Since Italy and Spain are facing liquidity, not solvency issues, the guarantee would probably never be used, and the ECB would collect fees for its service.

--Bonnie Kavoussi

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Credit Agricole, one of France's largest banks, plans to slash up to 2,300 jobs as European markets come under stress and the European economy slides into recession, according to The New York Times.

"It's clear that at least 1,700 jobs will go at the corporate and investment bank," said Régis Dos Santos, head of the French national banking union, which found out about the plans from Credit Agricole's executives, according to the NYT. Dos Santos added that another 600 jobs could be cut from the consumer side of the business.

--Bonnie Kavoussi

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German Chancellor Angela Merkel again on Wednesday eliminated the possibility of issuing government bonds backed by the eurozone as a whole, which some economists say would calm the bond markets and end the crisis, according to the Wall Street Journal.

Merkel said that though the eurozone must move toward a fiscal union, euro bonds "aren't suitable as a rescue measure," according to the WSJ.

--Bonnie Kavoussi

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By slashing their budgets, European countries are pushing themselves into a recession that will make it even harder for them to reduce their deficits as tax revenues fall, social service needs rise, and economic growth collapses, Reuters reported on Wednesday.

"The expansionary fiscal contraction story is a lie. You don't cut your way to growth," Stephen Kinsella, professor of economics at the University of Limerick, told Reuters.

From the article:

From Athens to Dublin, and almost everywhere in between, administrations are imposing wave after wave of spending cuts and tax increases to persuade investors they are serious about improving their public finances and persuade them to start buying euro zone sovereign debt again.

The austerity zeal risks tipping the continent back into recession and a downward spiral of austerity as pitiful growth prospects undermine budgetary targets and ramp up debt burdens, meaning further austerity is required.

--Bonnie Kavoussi

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The value of the euro against the dollar plunged on Wednesday below $1.30 to a low of $1.2968, near the record low for the year in early January of 2012, according to the Associated Press. The plunge highlighted decreasing investor confidence in the future of the eurozone.

--Bonnie Kavoussi

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Jens Weidmann, president of the influential German central bank and a policymaker at the European Central Bank, said on Wednesday that he opposes further intervention by the ECB to bring down borrowing costs for governments, according to Reuters.

"I think the idea is astonishing that one can win confidence by breaking rules," Weidmann said.

Under European law, the ECB is not allowed to buy bonds directly from governments. It would require a treaty change for the ECB to be allowed to do so. Meanwhile, the ECB has been buying limited amounts of troubled government bonds from other investors.

--Bonnie Kavoussi

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Ireland and the three Baltic states (Latvia, Lithuania, and Estonia), which embarked on budget cuts earlier than other European countries, saw their household consumption suffer the largest relative declines in the European Union, according to Eurostat, the EU's official statistics agency, The Wall Street Journal reports.

Household consumption in Ireland plummeted to 102 percent of the EU average in 2010 from 109 percent two years ago, in Lithuania consumption fell to 61 percent from 70 percent, and consumption in Latvia fell to 50 percent from 59 percent. In contrast, household consumption in Greece, which is in a depression, fell to 101 percent of the average from 104 percent, and in Portugal it increased from 83 percent to 84 percent of the EU average.

--Bonnie Kavoussi

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Angela Merkel has told the Bundestag that the UK is still a "very secure partner" in the EU, despite its veto over a new treaty on Friday, the BBC is reporting.

The chancellor said the countries had decided to have an "intermediate contract".

"I regret that the UK has not been able to join us on this journey," she said.

"But I also believe it's an important partner in the European Union... Great Britain has its own vital interest that the eurozone will overcome its own financial crisis."

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Just published on HuffPost UK - how the market-driven crisis response has further driven a wedge between the EU's institutions and politicians and its people.

There is a growing "legitimacy deficit" in the union, which has been widened by the crisis. As Jan Techau, from the Carnegie Endowment for International Peace, said:

"If the European Union wants to go ahead with the integration steps that they agreed upon at the last summit, they have to develop a system on the other side of the spectrum that allows for popular participation. You have to come up with some idea about how you can pull people into the political process. That means elections."

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As Reuters reports, the difference between the Italian and German bond auctions could hardly be more pronounced. Germany will pay just 0.29% on debt sold today - lower even than a month ago, before the EU summit.

Sweden, outside the eurozone and triple-A rated, also saw investors willing to accept very low yields on an auction of 5-year bonds on Wednesday.

Expectations that measures to be agreed at the summit would prompt more aggressive ECB bond buying -- coupled with a new austerity package by the Rome emergency government aimed at staving off financial disaster -- had driven Italian yields lower last week.

But selling pressure returned after ECB President Mario Draghi dashed hopes the central bank would ramp up its purchases in response to the EU agreement on more stringent fiscal rules.

ECB sources told Reuters purchases would remain limited for the time being but analysts say a radical shift may be needed next year if the situation deteriorates.

As the Reuters story says, almost everyone was expecting the European Central Bank to intervene. It didn't, and until it changes its mind, there is little hope that investors will change their minds.

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By this time on Tuesday we had seen stock markets heading up and down, but the direction of travel is all south today. The CAC-40 and the DAX have both slipped further - down 1.81% and 1.18%, respectively.

It is not all banks, either. With industrial output figures pointing towards an imminent recession in the eurozone - hardly a surprise, but still not good news - other economically sensitive sectors, such as automotive manufacturers and mining companies, have also headed down.

The high yields on show at Italy's bond auction are also likely to have hit long term sentiment about that country's solvency.

Some of the fall is down to disappointment over a lack of stimulus from the US Federal Reserve last night, traders said, although there are so many factors in play, everyone could be trading on their own bad news.

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Investors have demanded a euro-era record high yield of 6.47% on five-year Italian bonds. This compares to a yield (the amount of interest investors demand on the debt) of 6.29% at a similar auction a month ago.

Despite the relative success of a Spanish 12-month debt auction yesterday, it seems that bond markets are only interested in short term paper from the eurozone periphery. This, effectively, means that investors are not holding out too much hope that heavily indebted countries in Europe will be in a much better place in the medium-to-long-term.

Markets are supposed to have been reassured that they will not face "haircuts" on their holdings or European debt - as those who own Greek bonds did - however, with a lot of uncertainty over the crisis plan still in the market, it is not surprising that investors are unwilling to make a call.

The rising cost of borrowing could undermine Italy's hopes of cutting its debt load and avoiding a bailout, and if the trend continues it could increase pressure on European institutions to find the resources to backstop Italian debt.

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Trade looks very thin on the French and German markets, but both are down - 1.13% and 0.49%, respectively, as of 10.30 GMT. It looks very much like the same story as yesterday, with uncertainty over Friday's deal eroding confidence, but not enough for investors to commit to the notion of failure.

With very little to add to the public debate in Europe until after Thursday's ECB meeting, it is hardly surprising that traders have been reticent to buy into an information vacuum.

The FTSE has much stronger volumes, but is also suffering - down 0.6% - on the back of yet more worrying economic data. Figures released by the Office of National Statistics on Wednesday showed that unemployment has hit 17-year highs in the UK, adding to fears that the country could slip back into a recession.

“Government austerity measures are taking their toll on employment numbers and will continue to do so for many months to come," Richard Driver, analyst at Caxton FX said in an email. The private sector is failing to pick up the slack left by private sector cuts and the picture for UK youth employment is looking very poor, with the figure alarmingly up at 20%. Wage growth is also down, which is no surprise, but at least consumer inflation is coming down.

“The risks of another UK dip into recession are ever-increasing and today’s employment numbers do little to indicate otherwise.

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Eurozone industrial production fell - again - in October, according to figures out today. However, the 0.1% slip was moderate compared to the 2.0% slide in September. Even so, the data does not augur well for the final quarter, or for GDP overall.

Howard Archer, chief UK and European economist at IHS Global Insight, wrote in a note this morning:

Eurozone manufacturers are now very much on the back foot and finding life extremely challenging as domestic demand is hit by tighter fiscal policy across the region, squeezed consumer purchasing power, and heightened Eurozone sovereign debt tensions leading to tightening credit conditions and financial market turmoil.

Substantially adding to manufacturers’ problems slower global growth has hit foreign demand for Eurozone goods hard (as was highlighted by the fifth successive and sharp contraction in manufacturing export orders in November reported by the purchasing managers). Manufacturing activity has also come under pressure from the waning of inventory rebuilding and high jumps in input costs earlier this year.

At least though, input prices are now retreating, while the current softening of the euro will also be welcomed by most manufacturers.

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The talk of the British newspapers this morning is the uncertainty over whether the UK will still have to pay part of the €200bn loan to the International Monetary Fund (IMF) that was proposed as part of the EU agreement last Friday.

According to the IMF's internal magazine, €150bn of the €200bn loan that EU leaders have proposed to give to the IMF to fund future bailouts will be paid by eurozone member states, with the rest contributed by non-euro countries within the union.

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European markets have opened down, following US markets, which fell after the Federal Reserve gave no indication that it would take action to stimulate the economy, even as eurozone worries weigh heavy on investors there.

Here's a quick summary of Tuesday's action.

  • The "six pack" of measures designed to bring countries back on track towards fiscal stability came into force. Crucially, these include sanctions for countries that fail to keep their public deficit below 3% of gross domestic product (GDP), and an "excessive deficit procedure" - a readjustment programme - for governments with debt of more than 60% of GDP.
  • The IMF said that Greece's economy will shrink by 6% in 2012, more than the country's government's predictions of 5.5%.
  • European Markets slid back slightly, but volumes have been small as investors keep their powder dry.
  • A Spanish short term bond auction went fairly well, with good cover and more moderate yields, but 10-year debt from both Spain and Italy have seen their yields drifting upwards again.
  • The European Financial Stability Facility (EFSF) sold short term debt with strong cover, despite fears that it may see its debt downgraded.
  • David Cameron has been warned by senior EU officials that his veto on Friday won't protect the banks, and that his proposals would have damaged the single market.

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Filed by Harry Bradford  |