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Market Turmoil Will Hit Euro Zone Growth: Analysts

Economic growth in the euro zone will slow in the second quarter but remain positive, economists told CNBC.com, before it risks stagnating in the third quarter as businesses delay investments and the turmoil that has wreaked havoc in financial markets starts to affect the real economy.

Euros & Downward Graph
Steven Hunt
Euros & Downward Graph

The euro zone grew 0.8 percent in the first three months of 2011, up from the 0.3 percent growth recorded in the fourth quarter of 2010.

But that figure is set to drop back to 0.3 percent again for the second quarter of 2011 when the European Commission releases its first estimate for growth in the region on Tuesday, analysts said.

“We were expecting growth of 0.4 percent for the second quarter (quarter-on-quarter), but with the figures published by France today it is more likely to be 0.3 percent,” ING Chief European Economist Peter Vanden Houte said.

France on Friday said economic growth stalledin the second quarter.

Gross domestic product was zero in the April-June period, against expected growth of 0.3 percent.

“The economic data that has come out since June, July has all moved in the wrong direction,” Vanden Houte said, adding that references to a two-speed economy in the euro zone with a division between periphery and core no longer seemed appropriate." “The slowdown in growth appears to pertain to the whole of the euro zone,” he said.

“The ongoing negative market sentiment is now also weighing on the real economy.” UBS economists also warned that the turmoil in financial markets risked derailing the economic recovery.

Like ING’s economists, they expect a slowdown to 0.3 percent quarter-on-quarter for the second quarter.

Investors fled from risky assets following the S&P downgrade of the United States’ credit rating last week, putting pressure on peripheral spreads.

“This leads to the need of European countries to speed up fiscal tightening, which dampens GDP growth further,” UBS said.

“Although we do not believe credit tightness is an immediate threat to the euro area economy at this stage, declining willingness among banks to take on risk assets may dampen capex (capital expenditure) growth in the medium-term future,” it added.

Vandenhoute said that while he expected second-quarter growth to still be positive in the euro zone, GDP risked grinding to a halt in the third quarter as consumers curb spending but, more importantly, businesses postpone investments.

“The risks to growth then become self-fulfilling. Governments will need to consolidate their finances, but that puts further pressure on growth,” he said.

UBS pointed out that the US debt downgrade, the first in history, would probably also add to nervousness among companies.

“In the corporate space, it might lead to capex being postponed, as companies still have a fresh memory of what happened in 2008 when a relatively mild growth slowdown turned into something a lot worse. They will not want to fall behind the curve again. Households may just as well postpone spending on consumption, and save instead,” UBS said.