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