European Economy Risks Decoupling From Global Growth Recovery

Feb. 26 (Bloomberg) -- Europe’s economy may be coming unstuck from the global recovery as governments to the south of the region struggle to reverse budget deficits and consumers in the north pull back spending.

After the 16-nation euro economy almost stagnated in the fourth quarter, data this week showed the weakness reaching into 2010. Confidence among households and companies worsened unexpectedly, French consumer spending fell and bank loans to the private sector slid for a fifth month. At the same time, Standard & Poor’s said it may soon downgrade Greece again as the country grapples with the region’s largest budget shortfall.

Signs of a flagging recovery risk extending the euro’s slide against the dollar. They are also prompting Citigroup Inc. to advise investors to favor German government bonds and UBS AG to recommend European stocks with links to the faster-growing U.S., such as Daimler AG. As they cut their growth forecasts, economists predict slower interest-rate increases from the European Central Bank, whose governing council meets next week.

“Europe is where we see the biggest risk of a double dip at the global level,” said Julian Callow, chief European economist at Barclays Capital in London. “Europe has been lagging and we’ve continued to see better numbers in Asia and now the U.S.”

The European Commission yesterday said the euro-area recovery may not gather momentum until the fourth quarter and maintained its forecast for 0.7 percent growth this year. Citigroup cut its 2010 growth prediction to 1.1 percent, while raising its projection for the U.S. to 3.2 percent.

ECB Policy

Having begun the year predicting the ECB would lift its benchmark interest rate from a record low of 1 percent in the second quarter and to 2 percent by the end of the year, economists at Bank of America Merrill Lynch now don’t expect any increase until December.

Still, ECB policy makers meeting in Frankfurt on March 4 will take decisions on a further “gradual” phasing out of emergency measures introduced to fight the financial crisis, council member George Provopoulos said in an interview on Feb. 19. After already announcing the end of its 12- and 6-month loans, President Jean-Claude Trichet has indicated the bank may return to an auction procedure in some of its refinancing operations as a next step.

Stocks Decline

The outlook for the economy is unnerving investors and taking its toll on stocks. While the S&P 500 Index in the U.S. has risen 3.8 percent this year, Europe’s Dow Jones Stoxx 50 has dropped 9.5 percent, giving up almost half of its 2009 gain.

The euro has fallen almost 6 percent against the dollar this year on speculation the U.S. will recover faster and concerns about Greece’s fiscal problems. That decline may continue, according to Chris Turner, head of foreign-exchange strategy at ING Financial Markets, who says the euro “will struggle” to return to $1.37 and is more likely to slip to $1.30. The currency was at $1.3499 late yesterday in London.

Investors should favor German bonds over U.S. Treasuries because the ECB will lag behind the Federal Reserve in raising rates, Citigroup said on Feb. 23. At UBS, strategist Nick Nelson says that European companies making more than a quarter of their sales in the U.S. may benefit from the dollar’s strength and the U.S. rebound.

“There are tentative signs that the U.S. economy may be pulling ahead from Europe,” Nelson said in a Feb. 23 report, which cited luxury carmaker Daimler and publisher Wolters Kluwer NV among potential winners.

‘Stalled’

The euro-area is also troubling policy makers abroad. Bank of England Governor Mervyn King said on Feb. 23 that indications the U.K.’s largest trading partner has “stalled” threatens U.K. exports.

Alcatel-Lucent SA, the world’s biggest supplier of fixed- line phone networks, this month lowered its 2010 profit-margin targets. RWE AG, Germany’s second-largest utility, yesterday reduced its earnings growth forecast because of delays in developing power plants as well as oil and gas projects.

“It will take several years for the European economy to return to the level seen in 2008,” RWE Chief Executive Officer Juergen Grossmann said.

Rising borrowing costs on the back of Greece’s mounting fiscal problems may further undermine Europe’s economy. The impact of sliding sovereign bonds could be “broader, weighing further on the recovery” by pushing up financing costs, the commission said yesterday.

Growth Brake

The drive to shrink budget deficits in Greece, Spain, Portugal and elsewhere is another potential brake. Barclays’s Callow estimates that countries representing 20 percent of the euro region’s output will have a fiscal tightening of 2 percent of gross domestic product in 2010.

“The sovereign debt crisis in Europe’s periphery reinforces drags on euro-area growth,” said Michael Saunders, an economist at Citigroup in London.

Consumers will also keep retrenching as unemployment rises from December’s 11-year high after climbing slowly last year when government aid limited firings, said Gilles Moec, an economist at Deutsche Bank AG in London. Spending may also suffer as governments cut programs used to stoke consumer demand in 2009.

“Now we’re getting the backlash,” said Moec, who predicts global and euro-zone growth of 4.1 percent and 1.1 percent, respectively, this year. “Domestic demand is feeling the lagged effects of the recession.”