Another Tough Year For Europe’s Periphery

The weakening euro will eventually help Germany to revive its export sector and contribute to growth. However other countries in Europe are less lucky.

Tough Year Europe's Periphery

 

I mbalances within Europe have developed gradually since the creation of the eurozone, resulting in a cumulative current account surplus in the core countries and a current account deficit in the non-core areas. Fiscal austerity is limiting growth, which contributes to a rebalancing across countries by dampening import demand. The extensive fiscal austerity measures implemented in Spain, Italy and other non-core markets have offset the automatic stabilizers that otherwise would smooth out GDP growth in times of crisis, so the recession could be quite severe within these countries. S&P’s real GDP forecast for the eurozone is +0.2% in 2012, so a less rosy growth outcome could trigger more downgrades.

Our model projects eurozone GDP of about -1% this year.

The mild recession represents our base case scenario for the euro area as a whole, but this will be concentrated in the periphery.

Bottom line: Recessionary forces are significant in the peripheral countries, which keeps pressure on sovereign spreads as these countries struggle to meet debt targets. Stay neutral non-core Europe within a global hedged fixed income portfolio until there are clearer signs of growth and lower political risk.

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